The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research

In our paper “The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research”, Peter Wysocki and I review the empirical literature on the economic consequences of disclosure and financial reporting regulation, drawing on U.S. and international evidence. The paper includes an extensive review of the literature on mandatory IFRS adoption.

Disclosure and reporting regulation is an important and recurring policy issue that deserves significant attention by academic research. Further fueling demand for this research, policy makers, regulators, and standard setters are increasingly asked to conduct cost-benefit (or economic) analyses of intended as well as past regulation and standards. While we focus primarily on corporate disclosure and financial reporting, mandated disclosure is used in many other areas, such as product quality, consumer protection, conflicts of interest, environmental policy, health care, etcetera. In these areas, disclosure mandates are increasingly used in lieu of regulation that explicitly stipulates or prohibits certain behaviors, the idea being that mandated disclosure and transparency incentivize desirable behaviors and discourages undesirable ones. The widespread use of disclosure regulation in many different areas underscores the importance of disclosure and transparency as a research topic that goes beyond corporate reporting. Thus, understanding the economic effects of disclosure regulation is of first-order importance, not just for accounting and finance. Given this policy relevance, the review highlights the challenges with: (i) quantifying regulatory costs and benefits, (ii) measuring disclosure and reporting outcomes, and (iii) drawing causal inferences from regulatory studies.

The review’s starting point is that the theoretical case in favor or against disclosure and reporting regulation is not ex ante obvious and that the relative magnitudes of various costs and benefits that arise from a mandate are largely an empirical matter. This motivates the focus on empirical studies. We first discuss empirical studies that link disclosure and reporting activities to firm-specific and market-wide economic outcomes. Understanding these links is important when evaluating regulation. Next, we synthesize the empirical evidence on the economic effects of disclosure regulation and reporting standards, including the evidence on mandatory IFRS adoption. Several important conclusions emerge. First, we generally lack evidence on market-wide effects and externalities from regulation, yet such evidence is central to the economic justification of regulation. In addition, because studies typically do not identify or compute counterfactuals, the empirical literature to date has little to say about the efficiency or desirability of existing disclosure and reporting regulation. Second, evidence on causal effects of disclosure and reporting regulation is still relatively rare. Studies often struggle to identify counterfactuals, unaffected control groups, and/or natural experiments that would allow a clean identification of the regulatory effects and their economic consequences. For most regulatory changes, we are unable to provide causal estimates of the costs and benefits, let alone elasticities for the capital-market effects and other outcomes of disclosure and reporting mandates. Thus, while we have a lot of evidence that is qualitatively useful, we are still far from being able to perform quantitative cost-benefit analyses. Third, we lack evidence on the real effects of disclosure and reporting regulation. These limitations provide many research opportunities.

Finally, to make significant progress with respect to the (causal) estimation of regulatory effects and cost-benefit analysis, researchers likely need help from legislators and regulators. If we want better economic analysis, then we need to design regulation with ex-post analysis in mind (e.g., regulators should consider including thresholds or implementing the rules in a staggered fashion). In addition, we need more pilot studies and field experiments. Such studies would also facilitate ex-ante economic analysis and could mitigate the risks of unintended consequences.

Christian Leuz is the Joseph Sondheimer Professor of International Economics, Finance and Accounting at the University of Chicago's Booth School of Business.