Disclosure Regulation in the Commercial Banking Industry: Lessons from the National Banking Era

• Date: 01 March 2018
• DOI: http://doi.org/10.1111/1475-679X.12193
• Published date: 01 March 2018
• Author: JOÃO GRANJA

DOI: 10.1111/1475-679X.12193

Journal of Accounting Research

Vol. 56 No. 1 March 2018

Printed in U.S.A.

Disclosure Regulation in the

Commercial Banking Industry:

Lessons from the National

Banking Era

JO˜

AO GRANJA

∗

Received 11 July 2015; accepted 12 December 2016

ABSTRACT

I exploit variation in the adoption of disclosure and supervisory regulation

across U.S. states to examine their impact on the development and stabil-

ity of commercial banks. The empirical results suggest that the adoption of

state-level requirements to report financial statements in local newspapers is

∗Booth School of Business, The University of Chicago.

Accepted by Stephen Ryan. I thank the members of my dissertation committee for their

support and help: Christian Leuz (chair), Randall S. Kroszner, Raghuram Rajan, Haresh

Sapra and Douglas J. Skinner. I also thank Phil Berger, Jannis Bischof, Matthias Breuer,

Hans Christensen, Joseph Gerakos, Merle Erickson, Edward Kane, Sara Moreira, Amit Seru,

Chris Williams (discussant), Regina Wittenberg-Moerman, Anastasia Zakolyukina, Sarah Zech-

man, and workshop participants at the University of Chicago, UCLA, Northwestern University

(Kellogg), Wharton, NYU Stern, MIT Sloan, Columbia University, University of Michigan,

Harvard Business School, Boston College, Stanford University, NHH-Bergen, University of

California San Diego (Finance), and London Business School for the insightful comments

and discussions. I am indebted to Jessica Miller, archivist of the Michigan State Archives for

the access to electronic copies of the official directory and legislative manual of the State

of Michigan for the years 1889–1890. I also thank Marianne Haramoto and Daniel Burman

for excellent research assistance. I acknowledge the generous financial support provided by

the Sanford J. Grossman fellowship in honor of Arnold Zellner and the Deloitte Foundation

Fellowship program. Part of the work on this paper was completed while I held an assistant

professor appointment at MIT-Sloan. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

173

Copyright C, University of Chicago on behalf of the Accounting Research Center,2017

174 J.GRANJA

associated with greater stability and development of commercial banks. I also

examine which political constituencies influence the adoption of disclosure

and supervisory regulation. I find that powerful landowners and small private

banks are associated with late adoption of these regulations. These findings

suggest that incumbent groups oppose disclosure rules because the passage

of such rules threatens their private interests.

JEL codes: E44; E51; G21; G28; G32; G38; H23; K22; K23; L51; M41; M48;

N11; N21; N41; N81

Keywords: disclosure regulation; bank regulation; enforcement; financial

stability; bank failures; financial development; political economy of regula-

tion

1. Introduction

In the aftermath of the recent financial crisis, policy makers around the

globe promoted new rules and institutions to enhance the transparency

of the financial system. For example, the Dodd-Frank Act (DFA) required

the Federal Reserve Board to publish the results of periodic stress tests

administered to the largest financial institutions in the United States

(Sections 165(i)(1) and (2) of the DFA), the Federal Reserve Board

decided to publicly disclose its objections to the annual capital plans

submitted by some large financial institutions (Bernanke [2013]), and the

Financial Stability Board created the Enhanced Disclosure Task Force to

recommend best practices of financial reporting for financial institutions.

In spite of these recent regulatory efforts to promote reporting trans-

parency, we know little about how such regulations affect the stability and

development of the financial system.

Analyzing the implications of disclosure and supervisory regulation en-

tails many challenges (Mulherin [2007], Leuz and Wysocki [2016]). First,

changes in disclosure and supervisory standards are rare and usually of rel-

atively small importance. Moreover, significant changes in these standards

such as the Sarbanes-Oxley Act (SOX) and DFA usually affect the entire

economy and their effects are difficult to distinguish from those of concur-

rent macroeconomic events. Finally, causality often runs in both directions

as policy makers react to crises by adopting new legislation. It is, thus, dif-

ficult to distinguish whether regulations directly affect stability, or simply

are associated with stability because they are adopted in the aftermath of

banking crises.

I use the regional banking systems of the National Banking era as a quasi-

experimental laboratory to identify the impact of disclosure and supervi-

sory regulation on financial stability and development. From the beginning

of the National Banking era in 1863 until the creation of the Federal Re-

serve system in 1914, several U.S. state banking regulators expanded disclo-

sure and microprudential supervisory standards by requiring state banks

DISCLOSURE REGULATION IN THE COMMERCIAL BANKING INDUSTRY 175

to publish periodic reports of financial condition in local newspapers and

implementing periodic on-site examinations of state banks.

This setting allows me to address some of the challenges faced by studies

of disclosure regulation. These regulations represented a significant switch

from no disclosure and no periodic supervisory requirements to mandatory

publication of basic balance sheet information and regular on-site inspec-

tions of state banks by bank examiners. Moreover, different U.S. states

passed these regulations at different points in time, thereby mitigating

concerns that concurrent macroeconomic events drive the empirical

results. Finally, I compare the outcomes of commercial banks regulated

by state banking authorities (state banks) to those of commercial banks

regulated by federal banking authorities (national banks) that operate in

the same states and were subject to similar local economic shocks but were

not directly affected by the adoption of state disclosure and supervisory

regulations. This empirical strategy allays concerns that the endogenous

timing of adoption of these regulations explains the results.

The theoretical literature offers conflicting predictions about the effects

of disclosure and supervisory regulations (Beatty and Liao [2014], Bush-

man [2014], Goldstein and Sapra [2014], Acharya and Ryan [2016]). Pro-

ponents stress that such regulations are an important mechanism bonding

bank officers to provide information about the financial condition of their

institutions (Mahoney [1995]) that market participants subsequently use

to hold those officers accountable (Bushman and Smith [2001]). The idea

is that depositors and other stakeholders use financial reports to monitor

risk-taking and to demand adequate compensation for risks. Opponents ar-

gue, however, that financial reporting regulations reduce the stability of a

banking system. For instance, Morris and Shin [2002] suggest that infor-

mation disclosure—especially if imprecise—could raise the likelihood of

coordination failures among depositors and other short-term creditors and

precipitate bank runs.1Thus, whether disclosure and supervisory require-

ments foster financial stability and development is, ultimately, an empirical

question.

I start my empirical analysis by documenting that disclosure regulation

reduces the failure rate of state banks by approximately two percentage

points (p.p.). By contrast, the adoption of periodic on-site examinations

requirements does not significantly affect this failure rate. This reduction

is not driven by the contemporaneous implementation of other banking

regulations, by a small subset of states located in specific U.S. regions, or by

outliers. Overall, the results are consistent with the notion that the long-run

1During banking crises, city clearinghouses suppressed disclosure of financial information

of their individual members and acted like a single firm by disclosing aggregate information of

the clearinghouse (Cannon [1911], Gorton and Mullineaux [1987], Kroszner [1999]). These

actions suggest that 19th-century bankers worried about the destabilizing effects of disclosing

public information.