My article on the hydraulic theory of disclosure regulation

Geoffrey Manne —  2 August 2006

My article, The Hydraulic Theory of Disclosure Regulation and Other Costs of Disclosure is available at SSRN.  Although it will be published in the Alabama Law Review in January (or so), it is still in pretty rough form — the timing of various events dictated submission to law reviews before I solicited comments or finalized some of the article.  So I can truly say that all errors (and there are surely several) are mine.  But I would welcome comments and criticisms, as I do plan to do some revising before the article goes to print.

For those who may not have been keeping track, here are a couple of the blog posts on which the article is based (or is it the other way around?):

On disclosure: A continuing series

On disclosure: The hydraulic theory

On disclosure: Hands-tying

On disclosure: Shame?

And here’s the abstract:

This article argues that mandatory securities disclosure regulation has unanticipated and ill-considered consequences. Disclosure regulation makes some forms of behavior more expensive relative to others. Rational actors will respond by shifting some conduct into comparatively cheaper outlets. And these alternative behaviors may actually be less beneficial than the regulated, deterred behavior. Likewise, required disclosure of corporate information to investors makes shareholder governance less costly and more likely, even where it should be deterred. In essence, disclosure regulation effectively proscribes, it does not prescribe. Thus, depending on the viability of other behaviors, forced disclosure may induce unwanted behavioral responses. The article identifies two broad concepts that encapsulate these dynamics. The first is a “hydraulic theory” of securities disclosure regulation. Under this theory, disclosure regulation triggers behavioral hydraulics which may lead to an undesirable shift in executive behavior, as well as an undesirable shift in the pool of candidates for corporate executive positions. The second is an information cost theory of securities disclosure regulation. Under this theory, mandated disclosure is both unnecessary to market efficiency and affirmatively harmful to firms’ competitive schemes of corporate governance.

By the way — I finally got around to uploading a copy of my 1999 Wisconsin Law Review article on agency costs and charitable organizations.  In case you’re interested, it’s now available here.  Here’s the abstract:

This article uses property rights theory and the theory of the firm to analyze the behavior of the participants in nonprofit organizations. It locates the failure of nonprofit oversight in the confluence of strict standing rules and nearly insurmountable agency costs. The article repudiates the conventional solutions to the problem (ranging from relaxing standing limitations to restricting the use of the nonprofit form), and proposes a contractual solution through which nonprofits or their founders would secure the services of a set of independent agents to monitor and, where appropriate, enforce the nonprofit’s charter and the relevant fiduciary rules through judicial action. Because the monitoring agents would function within a market framework, market controls should operate to constrain the behavior of these agents. Thus donors, philanthropists, and beneficiaries would receive the benefit of effectively monitored corporate (or trust) agents who do not present a significant agency cost problem. The result should be increased accountability on the part of nonprofit agents to their donors or patrons without the serious threat of frivolous suits or politically-selective attorney general enforcement.

Geoffrey Manne


President & Founder, International Center for Law & Economics