More rules, less information

A STUDY OF ON THE REPORTING OF RISK BY OIL COMPANIES LISTED ON 20 FINANCIAL MARKETS SHOWS THAT VOLUNTARY DISCLOSURE OF NONFINANCIAL RISKS DECREASES WITH A HIGH LEVEL OF MANDATORY DISCLOSURE BECAUSE COMPANIES NO LONGER PERCEIVE IT AS BENEFICIAL. REGULATORS AND MARKET AUTHORITIES ARE WARNED

by Claudia Imperatore, assistant professor at Department of accounting

In the last decades, regulators increasingly required firms to disclose non-financial information to satisfy the information needs of a wider set of stakeholders. However, there is no consensus on whether mandating more disclosure is the optimal strategy to improve a firm’s information environment. On the one hand, scholars suggest that disclosure regulation is not needed as firms have incentives to disclose information to reduce the cost of capital and ease access to external funds. On the one hand, others argue that disclosure regulation is necessary as firms are reluctant to provide information because of the costs of collecting and processing the information as well as the fear to reveal sensitive data to competitors. Moreover, absent regulation, managers may disclose low-quality information that maximizes their interests rather than outsiders’ information needs. In a study co-authored with Claudia Arena and Saverio Bozzolan, we shed new light on the issue by analyzing risk reporting by listed oil companies in 20 financial markets during the period 2009-2014. Oil companies are highly exposed to both financial and strategic risk. According to IFRS 7, firms have to disclose information on financial risks (i.e., credit risk, market risk, and liquidity risk), while they are not required to provide information on non-financial risks (i.e., environmental, reputational, and operational risk). We exploit this feature to create two disclosure indexes: one for the mandatory disclosure of financial risks, and one for the voluntary disclosure of non-financial risks. We document that voluntary risk disclosure increases with the level of mandatory risk disclosure until a certain point after which the relation reverses and firms reduce voluntary disclosure.

Our evidence has two relevant insights. First, it shows that forcing firms to disclose one type of information has indirect implications on the firms’ choice to voluntarily disclose related information. Hence, corporate disclosure choices are part of a broader information strategy so disclosure decisions should not be analyzed on a standalone basis. Moreover, we document that the relation between different disclosure choices can be quite complex. Higher mandatory disclosure increases the credibility of information thus incentivizing firms to disclose more information voluntarily. However, this complementary relation holds until a certain level of mandatory disclosure, after which firms perceive voluntary disclosure as less beneficial. Indeed, information asymmetries have already been mitigated by the high level of mandatory disclosure so providing additional information is more of a cost for the firm. As a result, for a high level of mandatory disclosure, firms are less likely to voluntarily disclose information. We also find that this dynamic is more likely to occur for firms more exposed to risks suggesting that the relationship between mandatory and voluntary disclosure hinges upon the perceived costs and benefits which in turn vary depending on firm characteristics. Thus, mandating firms to disclose more information can have the unintended consequence of decreasing firms’ incentives to release additional information. These insights are relevant to lawmakers, and market authorities as they suggest that, at the moment of designing new disclosure rules, they should consider pre-existing pressures on firms to disclose. The interrelationships among disclosure choices imply that the effectiveness of the disclosure rules should not be assessed by only considering the impact on one disclosure type. A broader perspective that considers other disclosure contents and tools is also necessary, especially nowadays that firms are subject to a demand for information coming from a heterogeneous array of stakeholders.