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

• Date: 01 May 2016
• Published date: 01 May 2016
• DOI: http://doi.org/10.1111/1475-679X.12115

DOI: 10.1111/1475-679X.12115

Journal of Accounting Research

Vol. 54 No. 2 May 2016

Printed in U.S.A.

The Economics of Disclosure and

Financial Reporting Regulation:

Evidence and Suggestions for

Future Research

CHRISTIAN LEUZ

∗AND PETER D. WYSOCKI

†

ABSTRACT

This paper discusses the empirical literature on the economic consequences

of disclosure and financial reporting regulation, drawing on U.S. and inter-

national evidence. Given the policy relevance of research on regulation, we

highlight the challenges with (1) quantifying regulatory costs and benefits,

(2) measuring disclosure and reporting outcomes, and (3) drawing causal

inferences from regulatory studies. Next, we discuss empirical studies that

link disclosure and reporting activities to firm-specific and market-wide eco-

nomic outcomes. Understanding these links is important when evaluating

regulation. We then synthesize the empirical evidence on the economic ef-

fects of disclosure regulation and reporting standards, including the evidence

on International Financial Reporting Standards (IFRS) adoption. Several im-

portant conclusions emerge. We generally lack evidence on market-wide ef-

fects and externalities from regulation, yet such evidence is central to the

∗University of Chicago and NBER; †University of Miami.

Accepted by Philip Berger. We thank Matthias Breuer, Hans Christensen, Joao Granja,

Luzi Hail, Mark Lang, Mark Maffett, Valeri Nikolaev, Ahmed Tahoun, and Laurence van

Lent for helpful comments as well as Andrew Karolyi and Andrei Shleifer for comments

on an earlier version of this survey. Special thanks go to Pietro Bonetti for his com-

ments and assistance. This paper draws upon, extends, and replaces an earlier unpub-

lished survey paper entitled “Economic Consequences of Financial Reporting and Disclo-

sure Regulation: A Review and Suggestions for Future Research” (Leuz and Wysocki [2008]).

An online appendix for this paper can be downloaded at http://research.chicagobooth.

edu/arc/journal-of-accounting-research/online-supplements.

525

Copyright C, University of Chicago on behalf of the Accounting Research Center,2016

526 C.LEUZ AND P.D.WYSOCKI

economic justification of regulation. Moreover, evidence on causal effects of

disclosure and reporting regulation is still relatively rare. We also lack evi-

dence on the real effects of such regulation. These limitations provide many

research opportunities. We conclude with several specific suggestions for fu-

ture research.

JEL codes: D78; D82; G14; G18; G30; G38; K22; K42; M41; M42

Keywords: transparency; regulation; accounting standards; capital markets;

institutional economics; international accounting; disclosure; IFRS; politi-

cal economy; cost–benefit analysis; real effects

1. Introduction and Overview

This study reviews the empirical literature on the economic consequences

of disclosure and financial reporting regulation, summarizing U.S. and

international evidence. Our focus on regulation reflects that corporate

disclosure and financial reporting are frequently regulated, mandated, or

standardized. Therefore, regulation and standardization are core issues

for financial accounting. This does not imply that disclosure and financial

reporting have to be regulated or could not arise voluntarily. But, undoubt-

edly, 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.1

Three developments that have spurred disclosure and financial report-

ing regulation around the world make our review timely. First, a series of

financial crises and corporate scandals leading to calls for regulatory re-

form. The Asian financial crisis of 1997, the Enron scandal in the United

States, and the financial crisis in 2008 are but a few important examples. In

the aftermath of these events, policy makers and regulators enacted signifi-

cant changes to disclosure and reporting regulation. Second, over the past

decade, many countries have adopted International Financial Reporting

Standards (IFRS) in an attempt to increase the harmonization and global

convergence of accounting rules and reporting standards. Third, recent na-

tional debates about the competitiveness of countries’ capital markets and

the increasing internationalization of capital markets have spurred discus-

sions about reforms to securities and disclosure regulation.2These three

developments have motivated a large empirical literature, which we review

in this paper. As disclosure and reporting regulation has become a global

1See, for example, Meeks and Meeks [2001], Schipper [2010], Bartlett [2014], Coates

[2014], Cochrane [2014], and Posner and Weyl [2013, 2014].

2Examples are the debates in the European Union (e.g., Lamfalussy [2000]) and the

United States (e.g., Commission on the Regulation of U.S. Capital Markets in the 21st Century

[2007]).

DISCLOSURE AND FINANCIAL REPORTING REGULATION 527

issue, we emphasize international evidence. We also recognize that regulat-

ing disclosure and setting accounting standards are intertwined, which is

why this review combines evidence on the economic effects of disclosure as

well as financial reporting regulation.3

While we focus primarily on corporate disclosure and financial report-

ing, mandated disclosure is used in many other areas, such as product

quality, consumer protection, conflicts of interest, environmental policy,

health care, etc. 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 de-

sirable behaviors and discourage undesirable ones. This incentive or gover-

nance role of disclosure regulation deserves greater attention—a point that

we emphasize in this review. The widespread use of disclosure regulation in

many different areas underscores the importance of disclosure and trans-

parency as a research topic that goes beyond corporate reporting. Thus, in

our view, understanding the economic effects of disclosure regulation is of

first-order importance, not just for accounting and finance.

For the purpose of this review, we deliberately use a broad definition

for disclosure and reporting regulation, which includes a central authority

formally creating and interpreting disclosure and reporting rules, moni-

toring compliance with these rules, and enforcing and imposing penalties

for deviations from the rules.4Disclosure and reporting rules stipulate that

firms and hence managers/owners of firms provide certain information

to investors, consumers, contracting parties, regulators and government

agencies, or the general public.5Consistent with this broad definition, we

do not review studies on a particular accounting standard or narrow dis-

closure rule.6Instead, we focus on new disclosure mandates (e.g., the Se-

curities Exchange Act), major extensions of the entire disclosure regime

3Other survey papers on the empirical disclosure literature include Healy and Palepu

[2001], Core [2001], and Beyer et al. [2010]. Our focus is on regulation and mandated

changes in reporting standards.

4For example, the Organisation for Economic Co-operation and Development (OECD) de-

fines regulation “as imposition of rules by government, backed by the use of penalties that are

intended specifically to modify the economic behavior of individuals and firms in the private

sector” (https://stats.oecd.org/glossary/detail.asp?ID=3295). We acknowledge that informal

norms and common practices can and do arise without central coordination and mandate.

However, for the purposes of this review, the term regulation refers to mandated sets of for-

mal rules and associated penalties that are coordinated and implemented by one or several

central authorities, which are not necessarily government authorities, but could also be private

standard setters.

5The disclosed information is also defined broadly and not confined to reported numbers

or footnotes in the financial statements. Our definition of rules encompasses financial report-

ing and accounting standards. However, we largely exclude work on bank regulation as it is

separately discussed in this journal issue by Acharya and Ryan [2016].

6Studies on the effects of particular standards have been reviewed in prior surveys (see,

e.g., Gonedes and Dopuch [1974], Holthausen and Leftwich [1983], Watts and Zimmerman

[1986], Fields, Lys, and Vincent [2001], and Kothari [2001]).