Comments on: On disclosure: The hydraulic theory

By: Ideoblog

Ideoblog — Fri, 24 Feb 2006 16:36:33 +0000

What the world needs now: still more compensation disclosure? …

I have been criticizing at some length the SECâ€™s 300 plus page executive compensation disclosure proposal, e.g., here. See also my Executive Compensation archive for other recent posts. So is there any criticism Iâ€™ve left out? Apparently yes â€“ that…

By: Brainwidth » Blog Archive » New SEC Executive Compensation Proposal

Brainwidth » Blog Archive » New SEC Executive Compensation Proposal — Sat, 18 Feb 2006 04:35:42 +0000

[...] Securities regulation is the United States is primarily centered on required disclosures, and this latest proposal by the SEC has renewed debate on disclosure regulation. Larry Ribstein has a number of posts criticizing the proposal, Geoffrey Manne has two very interesting posts discussing the costs of disclosure regulation, Stephen Bainbridge weighs in on disclosure regulation here and here. [...]

By: Ideoblog

Ideoblog — Mon, 13 Feb 2006 12:32:06 +0000

More bones in the chicken soup…

When news of the SECâ€™s executive compensation proposal initially hit, I called it â€œchicken soupâ€? in the sense of being more innocuous than other things the SEC could have done. Spurred by Geoff Manne, Iâ€™ve since recanted. Iâ€™ve previously discussed…

By: Michael Guttentag

Michael Guttentag — Thu, 02 Feb 2006 00:56:16 +0000

Geoff. All excellent comments. I can tell you how I try and address your concerns, but I think you have nicely summarized a set of plausible challenges to what I say. With respect to disincentives caused by disclosure â€“ my vote is for â€œproduce and discloseâ€? rules, such as those that require financial statements disclosures. I try in the article to specify exactly which kinds of additional information should be required to be disclosed by looking to disclosure requirements in private transactions. The thought is that this type of rule is better than a conditional â€œdisclose if producedâ€? rules, which would inevitably mess up information gathering incentives. The second point I would make is that it would be silly to simply require the disclosure of all competitively disadvantaging information, and I think this is where Fox errs. The model attempts to show that there are particular categories of information for which non-disclosures is especially socially costly, because, for example, of the impact of non-disclosure on agency costs. Finally, it is not obvious if the world becomes less competitive or more competitive if this information is required to be disclosed.

Does the SEC do what I recommend? Certainly not in a systematic, thoughtful, or careful way, but they may be stumbling in the right direction, if I am to be believed.

By: Geoffrey Manne

Geoffrey Manne — Thu, 02 Feb 2006 00:30:10 +0000

I didn’t mean to exclude your justification for mandatory disclosure from my brief (2 example) mention of justifications in my comment — there I thought of the credible commitment argument because it is an argument rooted in firms’ (theoretical) view of what’s best for themselves rather than someone else’s, and B&F because I have been thinking about executive compensation. The interfirm externalities argument you propound is certainly a plausible one.
Now, am I convinced by it? Of course not (but that’s just my own intransigence talking). But really, I’m not convinced because (unless I misunderstand your article) the claim that interfirm externality correction justifies disclosure does not take account of the ways in which required disclosure might alter firm behavior in socially costly ways. Not that I have a model to capture the effect, but I can easily imagine that this might occur. If you require firms to disclose competitively-disadvantageous (but, in theory, socially advantageous) information, how will that affect their behavior? Will it not affect behavior? Could the offset eat up all or most of the benefit? I guess my sense is that, although permitting firms to keep secret information that could be valuable to competitors is a “cost” of non-disclosure, it is the price we pay for spurring the animal spirits and maximizing incentives to innovate and compete. Requiring every firm to operate like they were all part of one big firm, not competing in capital, labor and product markets, would be disastrous. Not that this is precisely what you are advocating, but, again, unless I misunderstand, it must be a move in that direction (ok — so they don’t act just like one big firm because they do still compete in these markets, but if we magnify the cost of failure and minimize the gains appropriable from success (by both managers and by firms at large), how much competitive incentive do we lose? I just don’t see how that factors in to your model. But I’m no expert on formal models — maybe I’m missing something.

By: Michael Guttentag

Michael Guttentag — Wed, 01 Feb 2006 22:20:14 +0000

Geoff. You were very kind to cite my article: An Argument for Imposing Disclosure Requirements on Public Companies, but I take it you were not impressed by the conclusion. In my article, as the title suggests, I argued that there is a substantial market failure in public company disclosure practices resulting from the inability of firmâ€™s making disclosures to capture the benefits these disclosures provide to the firmâ€™s competitors, so called interfirm externalities. This is an argument different than the credible commitment argument offered by Edward Rock (among others) and the reporting consistency argument alluded to above by William Goodwin (and discussed in greater detail by John Coffee in 1984 and Douglas Diamond in 1985).
The possible significance of interfirm externalities is not new to me. Merritt Fox made much of this as the possible cause of a significant market failure in firm disclosures, but most of the arguments he offered were effectively rebutted by Roberta Romano in her papers arguing for issuer choice in securities regulation. I take up the Romano and Fox dialogue in my article. One of the shortcomings that Romano pointed out in Foxâ€™s argument was the lack of an adequate financial model linking interfirm externalities and gains from securities regulation. I believe I have rectified this shortcoming by developing such a model, which is posted on my SSRN cite, work that was completed subsequent to the publication of the article you cite.
Is there no market failure that justifies mandatory securities regulation? I think this is still an open issue.

By: William Goodwin

William Goodwin — Wed, 01 Feb 2006 00:11:59 +0000

Isn’t one obvious benefit of making disclosure mandatory that it harmonizes the reporting of all public firms and therefore reduces search costs for investors trying to compare potential investments? If, as many fundamental investors do, you view excess executive compensation (that is, compensation that is well above peer-group pay without any corresponding outperformance) as a sign that a company’s corporate governance is weak, and that therefore it may be headed for trouble, you want to be able to access the information about compensation as quickly and efficiently as possible, and you want to be able to aggregate the data across a wide range of companies and classes. Mandatory disclosure makes that significantly easier.

Another benefit, obviously, is that it makes securities pricing more efficient, by releasing more information to the marketplace. Given the fundamental importance to society of the public markets in allocating capital, there is an abiding social interest in ensuring that that allocation is as efficient and as accurate as possible. The marginal cost of the regulations needs to be weighed not just against the marginal benefit to investors, but also against the social benefit of having more efficient securities pricing.

By: Geoffrey Manne

Geoffrey Manne — Mon, 30 Jan 2006 22:43:06 +0000

Mike: Thanks for the comment. The important question, as always, is the marginal one (and the one for the marginal firm). I guess it’s possible that mandatory rules get us to the optimal point, but it’s extremely unlikely, given the inherent paucity of information possessed by regulators and the wide disparity among firms. Plus, even if so, the real question is, what do we get by making disclosure mandatory? Ed Rock has a nice, but to me not-fully-persuasive answer that at least identifies a reason firms may opt for a mandatory regime. Bebchuk and Fried would argue that we need it to correct an agency problem, but now we’re back to guessing whether the marginal gain of increased disclosure is worth the marginal cost (and, as you point out, whether that’s what’s going on in the private agreements). One big difference between the private/public contexts is that when compensation is voluntarily disclosed there is probably less incentive to subvert the disclosure than when it is imposed from outside. I’m sure there’s a name for this cognitive effect. Still, I think looking at private party agreements would be a good source of data here, but ultimately not all that compelling on the mandatory question.

Your point about politics is right on — in fact I stole my “hydraulic theory” moniker from Pam Karlan and Sam Issacharoff writing about campaign finance reform.

By: Ideoblog

Ideoblog — Mon, 30 Jan 2006 14:03:49 +0000

The SEC’s compensation proposal on display…

The SECâ€™s compensation proposal is out. Iâ€™ve browsed but not read it. Some initial reflections: 1. Itâ€™s 370 pages long. In doing a cost-benefit, consider the resources involved just in the adoption process, let alone compliance. 2. There are going…

By: The James McConvill Blog » Blog Archive » Talking About the Cost of Disclosure

Sun, 29 Jan 2006 22:18:44 +0000

[...] In an excellent post on Truth on the Market, US law professor Geoffrey Manne agrees. Manne moves away from the contemporary rhetoricÂ in favour of enhanced disclosure, to argue that there may indeed be substantial costs of ramping up disclosure- be that in relation to executive pay,Â or securities regulation more generally. [...]