Review of Accounting Studies, 1,285307 (1996) @ 1996 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands. Private and Public Disclosures and the Efficiency of Stock Prices SUNIL DUTTA HaasSchool of Business, University ofCalifornia,Berkeley, CA$W'~O Abstract. In this paper I examine the effects of private and public disclosures on the informational efficiency of stock prices. In addition to making a public announcement such as an earnings announcement, a public firm can make private disclosure to an analyst. If the analyst’s relative information advantage is below a threshold level, private disclosure to the analyst leads to more efficient stock price. I demonstrate that the allocation of information across market participants is an important determinant of price efficiency. While accounting regulators often argue the need for equal access to information, the paper shows that there are conditions under which a limited amount of informational inequality may lead to more efficient stock prices. A number of empirical studies have provided evidence consistent with the premise that some market participants such as security analysts have accessto information beyond that available to the public at large.’ In this regard, both anecdotal and survey evidence suggest that analysts consider firm management to be their most influential source of information.2 The fact that, in addition to making public announcements, firms make selective private disclosures raises interesting issues with regard to their choice of disclosure channels. My purpose in this paper is to analyze the effect of private and public disclosures on the informational efficiency of stock prices.3 My main result is that while a limited amount of private disclosure leads to a more efficient stock price, too much private disclosure can have a negative impact on price efficiency. I also show that firms with more informative public disclosure policies will optimally disclose less through analysts. Thus, firms with higher costs of public disclosures, or firms with information which cannot be credibly disclosed through the public channels, will disclose more through analysts. In the model which follows, a firm’s shares are traded by a potential information seller such as a sell-side analyst and sufficiently many investors. Before the trading begins, the firm releases a public signal which can be thought of as an earnings announcement. The analyst and investors can process the public data into private information at some cost.4 The firm can choose to assist the analyst in extracting even more value-relevant information from the publicly available data than he could extract on his own. If the analyst is not allowed to sell his information processing services to other investor$, I show that the firm’s stock price is most efficient when the analyst does not have any relative information advantage over other investors. This is because the number of investors who become information processors decreases in the analyst’s relative information advantage.6 In this setting without a viable market for private information, a price efficiency maximiz-