Finding a balance between mandatory and voluntary disclosure

TRR 266 researchers investigated how enforcement affects mandatory and voluntary disclosure.

How enforcement affects companies’ disclosure strategies

Voluntarily communicating favorable information (e.g. strong financial results or sustainability initiatives) to stakeholders like investors, consumers and the public can prove beneficial for companies and help them to gain trust as well as promote their business. Unfavorable information, however, tends not to be made public as it can impact the company’s reputation, financial performance, or stakeholder confidence and thus have a damaging effect on the company’s business. So, whether relevant information is disclosed to stakeholders largely depends on how well disclosure rules are enforced. The TRR 266 researchers Dirk Simons (University of Mannheim) and Benedikt Franke (University of Würzburg) developed a theoretical model, which analyzes the impact of enforcement on firms’ disclosure behavior. Their findings provide regulators with important insights for adjusting enforcement regulations.


Enforcement shapes how companies report information, anticipating potential stakeholder reactions. However, some fear that without sufficient enforcement, some companies might not disclose relevant information. Massive fines for non-compliance, like those mandated by the Securities and Exchange Commission (SEC) between 2015 and 2019, reflect this view: On average, the SEC required $2.908 billion in repayments and imposed $1.164 billion in penalties each year across 822 enforcement actions. Paradoxically, too much enforcement could disrupt how companies willingly share information. Hence, when do companies share information voluntarily and how does enforcement affect their disclosure strategies?


Which firms disclose voluntarily?

For high-quality firms to separate themselves from low-quality firms, voluntary disclosure is a popular tool. The assumption is: If there is no obligation to publish information, only those with favorable information (thus high-quality firms) will do so. This plausible effect depends on various factors including no disclosure costs and perfect anticipation of investors’ reactions. However, these assumptions may not always hold true. Extent theories suggest that not all firms have relevant information to disclose. This leads to a group of non-disclosing firms with the same average value. Consequently, low-quality firms are provided with incentives to intentionally remain silent. As a result, investors cannot distinguish between companies that intentionally remain silent and those that have no information to disclose and price them equally. This mimicking-behavior forms the basis for arguments supporting mandatory disclosure, particularly for low-quality firms that may not disclose enough information otherwise.


Enforcement – the Game Changer?

Enforcement plays a pivotal role in shaping companies’ disclosure behaviors. To explore the different effects on their voluntary and mandatory disclosure strategies, we considered the following scenarios.

Relaxing the Rules

Assume the following disclosure rule, which focusses – for sake of illustration – directly on the firm value: If a company has unfavorable information and falls short of a certain threshold, it has to disclose the information about its firm value. On the other hand, if a company has favorable information above the threshold, it is not obliged to disclose, but it can choose to do so voluntarily. What happens, if we assume that some firms do not obey the rule and remain silent although their firm value falls short of the mandatory disclosure threshold? If it actually stays silent and gets caught, it faces penalties proportional to its misconduct and has to correct its disclosure statement.

In our study, we assume that companies are caught with a certain probability. Companies with very low firm value information below the disclosure threshold will reveal their true situation according to the rules. However, companies with slightly better quality but still below the mandatory disclosure threshold choose to stay silent illegally, mixing in with higher quality companies that are not disclosing due to lack of information. For these silent rule-breakers, the fear of getting caught and punished is not strong enough to stop them from misbehaving. Firm slightly above the threshold decide to remain silent, too, but they do so rightfully. For them disclosure is not paying off in terms of stock prices. In our model, the best companies choose to disclose voluntarily, which means they strategically separate themselves from the rest of the market.

Stronger enforcement and penalties

If enforcement rules are stronger – so there is a higher chance of getting caught – and penalties are more severe, we see that companies’ disclosure behavior changes. More low-quality companies will comply with the rules and follow their obligation to disclose relevant information. Yet, stricter rules also make it less appealing for high-quality companies to share information voluntarily, making voluntary disclosure less valuable. In total stronger enforcement can result in less transparency.


Impact for regulators

Our model helps regulators understand how enforcement incentives impact both mandatory and voluntary disclosure decisions by companies. It uncovers unintended consequences to consider for readjusting regulation. We demonstrate that effective disclosure regulation leans on enforcement to ensure companies fulfill their mandatory disclosure obligations. However, promoting mandatory disclosure primarily through enforcement leads to the crowding out of market-driven solutions. Because enforcement incentivizes firms at the lower end of the value distribution to disclose, firms at the upper end of the value distribution have fewer incentives to separate via voluntary disclosure. In summary, our findings emphasize that further research is needed to guide policymakers in balancing the incentives generated by centralized approaches, such as enforcement, and those stemming from market-driven solutions like disclosure.



To cite this blog:

Franke, B. & Simons, D. (2024, June 21). Finding a balance between mandatory and voluntary disclosure: How enforcement affects companies’ disclosure strategies, TRR 266 Accounting for Transparency Blog.


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