Reporting Discretion, Market Discipline, and Panic Runs

This paper investigates the economic consequences of a financial institution’s reporting discretion in the context of bank runs. A fundamental-based run imposes market discipline on insolvent institutions, but a panic-based run shuts down institutions that could have survived with better coordination among investors. We augment a bank-run model with the financial institution’s discretion over reporting to investors. We show that reporting discretion reduces panic runs, but excessive reporting discretion weakens the market discipline. Moreover, one institution’s opportunistic use of reporting discretion exerts a negative externality on others.