Enforcement and disclosure

Abstract

Absent sufficient enforcement, disclosure regulations are often seen as inconsequential. However, enforcement could have unintended effects on firms’ incentives to disclose information voluntarily. We develop a model to analyze the impact of enforcement on firms’ mandatory and voluntary disclosure behavior. The model can accommodate different disclosure and enforcement regimes depending on its parameters, ranging from voluntary disclosure under stochastic information endowment to disclosure under an enforcement regime with punitive damages. In the generalized version, low-value firms disclose under a mandatory disclosure rule, medium-value firms do not disclose (some legally, some illegally), and high-value firms disclose voluntarily. Stronger enforcement does indeed increase the number of firms complying with the regulation. However, it also crowds out voluntary disclosure by making separation less attractive, resulting in a decrease in transparency overall. Nevertheless, stronger enforcement does still lead to positive capital market effects, such as lower mispricing. When we endogenize disclosure regulation, i.e., determine the rule according to firms’ preferences, there exists a unique standard where no majority prefers a marginal change to the regulation, and that increases in enforcement.