Regulation-Induced Disclosures: Is ‘More’ Actually ‘Less’?
University of Florida
Charlie Munger: Invert And Use “Disconfirming Evidence”
University of Exeter
March 4, 2016
Regulators and practitioners have expressed concerns that accounting disclosures have become too much and too complex resulting in negative consequences for companies and financial statement users. We investigate whether more regulation-induced disclosures are associated with more effort to prepare and use financial statements. We create an index measuring firms’ exposure to regulation-induced disclosures. We show that a higher index is associated with longer 10-Ks, a longer reporting delay and higher audit fees. A higher index is also associated with fewer analysts following the firm, lower analyst accuracy and a higher dispersion. Our findings suggest that increases in regulation-induced disclosures have unintended consequences.
Regulation-Induced Disclosures: Is ‘More’ Actually ‘Less’? – Introduction
This paper investigates the consequences of having more regulation-induced disclosures for both companies and sophisticated financial statement users. Over the past decades, changes in financial reporting regulations have resulted in a considerable increase in the amount of required disclosures.1 As a consequence, regulators, standard setters, and practitioners have expressed concerns that the steady increase in the volume of standards, regulations and interpretations has not only added to the costs and efforts involved in preparing financial reports but also affected users’ ability to make informed decisions (Herz 2005; Palmrose 2009; KPMG 2011; FASB 2012; Paredes 2013). We examine the consequences of increases in regulation-induced disclosures, i.e., increases in disclosures from the introduction of accounting standards and regulations, over the period 2000-2008 for companies and analysts. In doing so, we investigate whether more regulation-induced disclosures are associated with more costs for preparers and more effort for analysts.
Prior literature shows that disclosures have increased dramatically in volume and complexity. Loughran and McDonald (2011) report that the average length of a 10-K filing increased by about one-third, to almost 60,000 words, over the last 15 years. Likewise, a report by KPMG expresses concerns that value relevant information is often “hidden in plain sight” from investors due to the sheer quantity of information disclosed by firms (KPMG 2011). The report shows that from 2004 to 2010 overall disclosures in annual reports increased by 16 percent while footnote disclosures increased by 28 percent.
The general assumption is that more disclosure reduces information asymmetries since market prices reflect all available information. This assumption ignores however that financial statement users are bounded by the amount of information they can or are willing to process (Bloomfield 2002; Paredes 2003; Bloomfield 2012). As disclosure quantity increases, financial statement users eventually reach a point where their ability and/or willingness to process the information degrades because of limited capacity (Hirshleifer and Teoh 2003) or because the costs of processing the information become too high (Bloomfield 2002). Under these circumstances, more information is not completely revealed in market prices resulting in less efficient capital allocations (Paredes 2003). Bloomfield (2012) also argues that increased disclosure lowers investors’ ability to draw inferences from firms’ disclosure choices: When firms have to disclose everything, investors cannot infer the importance of information items from firms’ choices to disclose or withhold the item.
Although concerns have been raised that accounting information has become “too much” and “too complex” (Herz 2005; Palmrose 2009; KPMG 2011; FASB 2012; Paredes 2013), there is surprisingly little research on the consequences of financial reporting and disclosure regulation. Our paper answers the call in Leuz and Wysocki (2016) to provide more evidence on the aggregate outcomes of reporting and disclosure regulation, by examining whether more disclosures induced by accounting standards and regulations introduced between 2000 and 2008 made 10-K filings more difficult to understand and use. In doing so, our paper also tests, to some extent, Bloomfield’s (2002) Incomplete Revelation Hypothesis.
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