Highlights
- Firms often face complex decisions about whether to disclose their costs, with strategies varying widely across industries and market conditions.
- The study found that cost-disclosure decisions not only influence market competition but also affect how suppliers set input prices, which challenges traditional views on cost-related information disclosure.
- Results highlight the importance of considering both the nature of costs (endogenous versus exogenous) and supplier relationships when developing disclosure strategies.
Firms often guard private information regarding their costs. When other market participants cannot easily assess cost information, it can lead to firms deciding whether to disclose such cost information to external firms and consumers. In practice, disclosure decisions vary, in that some publicly listed companies regularly disclose their costs through official announcements or financial statements. Certain firms make cost transparency a corporate principle, whereas many do not disclose their cost information. These contrasting approaches raise the question of why some firms disclose cost information while others do not.
The generally accepted conclusion is that firms should disclose or conceal their cost information under quantity competition, as this can influence market competition. Under price competition, firms can conceal their cost information because disclosure intensifies market competition. In a case where two firms are under quantity competition, if one firm has a competitive advantage due to low cost, disclosing this information prompts its rival to contract output, thereby strengthening the focal firm’s advantage and increasing its profit. If the firm’s costs are high, disclosure can lead the rival to increase output, amplifying the focal firm’s disadvantage and shrinking its profit. The increase in high profits more than offsets the decrease in low profits, making disclosure beneficial under quantity competition.
Despite the prevalence of endogenous costs, strategies for firms regarding the disclosure of such costs remain unclear.
Exogenous costs, those determined by factors outside the direct control of the firm, are common in many industries, but there are also situations where firms’ costs are endogenously determined. For instance, manufacturers often rely on upstream suppliers for essential inputs, making their prices dependent on supplier decisions. Despite the prevalence of endogenous costs, strategies for firms regarding the disclosure of such costs remain unclear.
The researchers used a duopoly model in which two manufacturers produce differentiated products and compete either on quantity or price. The model was used to study manufacturers’ incentives to disclose costs to the market, with the key distinction that manufacturers source inputs from respective suppliers who set input prices after manufacturers make their disclosure decisions. To eliminate conventional reasoning for cost disclosure, it was assumed that manufacturers incurred no costs other than procurement and that there was no cost uncertainty.
The findings suggest that when manufacturers compete on price or source from a common supplier, both withhold their cost information to secure low procurement costs from their supplier.
The findings suggest that when manufacturers compete on price or source from a common supplier, both withhold their cost information to secure low procurement costs from their supplier. Conversely, when manufacturers source from independent suppliers and compete on quantity, both disclose their cost information. By making these disclosure decisions, manufacturers can convince their upstream suppliers or standard suppliers to charge lower input prices, thereby widening their profit margins.
The economic consequences of disclosure and nondisclosure were also analysed, particularly considering antitrust authorities’ concerns about how information sharing or withholding affects consumer welfare. When suppliers also have the option to disclose their contracts to downstream manufacturers, the suppliers’ disclosure incentives are not aligned with those of the manufacturers. However, when both suppliers and manufacturers can disclose, costs are always disclosed.
The study findings indicate that although endogenous costs are common and must be factored into any general picture of a business process, the conventional wisdom regarding disclosure of such costs should be applied with caution. Cost disclosure affects not only market competition but also how suppliers set input prices. It is not clear whether these effects alter firms’ disclosure incentives or not.
Firms must frequently determine whether to disclose their cost information to other market participants. In practice, strategies vary, with some firms disclosing and others withholding such information.
The analysis of four alternative scenarios under different types of market competition (price and quantity competition) and structures (independent suppliers and a common supplier) generated findings that depart from established views on cost disclosure.
First, manufacturers’ cost-disclosure strategies affect not only market competition but also how suppliers set input prices. Second, firms should consider various factors when making cost-disclosure decisions. Whereas previous research suggests that firms’ disclosure policies should depend on the nature of competition (price versus quantity competition), the study findings show that firms should also consider the nature of the costs to be disclosed (endogenous versus exogenous) and the market structure (common supplier versus independent suppliers).
This study provides preliminary insights into firms’ disclosure of endogenous costs, and its model focused exclusively on firms’ disclosure of cost information. It would be of interest to consider firms’ incentives to disclose other types of information, especially when such information can be endogenised.
Overall, the study suggests that firms must be cautious when applying conventional wisdom regarding the disclosure of endogenous costs, as such decisions can influence not only competitive dynamics but also supplier pricing strategies. The nature of costs and the structure of the market play critical roles in determining optimal disclosure strategies. The alignment or misalignment of disclosure incentives between manufacturers and suppliers further complicates the strategic landscape, highlighting the need for a nuanced approach to cost information disclosure.
Keywords: Disclosure, procurement cost, competition, transparency
* Learn more from the full research article here:
https://doi.org/10.1287/mksc.2022.0346
