Disclosure, Enforcement and the Valuation of Equity

Abstract

Empirical evidence shows that higher levels of disclosure and enforcement do not consistently translate into higher firm valuations. This observation implies a real-life setting in which a richer information environment can shift investors' risk premiums upwards or downwards. However economic literature does not convincingly explain why adverse effects can occur. To fill this gap in research, we provide a model beyond the standard principal-agent framework that can explain valuation effects from augmented disclosure and enforcement regulation. We also show that country differences in regulatory effectiveness do not align with the legal system, but instead with structural strengths or difficulties of an economy. In a six country setting, investigating Canada, France, Germany, Japan, the UK and the U.S., we systematically capture regulatory changes and document varying valuation effects from mandatory disclosure regulation. Our analysis shows that valuation effects are driven by the share of "bad news" firms, which is higher in economies with structural difficulties. Effects from higher levels of disclosure are thus neither generalizable across economies nor dependent on the legal system as previously hypothesized.