We next apply these general arguments about regulation specifically to the theory of disclosure

regulation Issuers of public securities face a competitive capital market populated by

sophisticated investors. Firms concerned with maximizing their value therefore have powerful
incentives to disclose all available information to obtain higher prices, because failure to disclose
would cause investors to assume the worst (Grossman, 1981; Milgrom and Roberts, 1986). In
the absence of disclosure, skeptical market participants would assume that the firm is hiding bad
news and bid down the price of the firms securities accordingly. Credibility of such disclosures
can be supported by reputational, legal, and contractual penalties for misreporting, and low cost
verification of accuracy

Firms may be unwilling to disclose voluntarily information that reveals proprietary information
to their competitors (Verrecchia, 1983). Such decisions are rational from the firm-specific
perspective, but do not incorporate potential economy-wide benefits. For example, such
disclosures can facilitate the allocation of capital to the highest value projects and promote
competition among firms that can promote productivity improvements and price competition that
benefits consumers.

Lambert, Luez and Verrecchia (2007) shows how disclosure by individual firms can have
system-wide benefits by allowing investors to better assess the covariance of payoffs across
firms and thus lower the cost of capital. Firm-specific disclosures can also have market-wide
benefits by reducing aggregate expenditures on information production as firms are likely the
lowest cost producer of corporate information and such disclosure can eliminate the duplicative
information collection efforts by capital market participants (Coffee, 1984; Easterbrook and
Fischel, 1984).

Huizinga and Laeven (2009) examines accounting discretion by U.S. banks during the 2007-
2008 time frame, documenting that banks used discretion to overstate the value of distressed
assets, and that banks with large exposures to mortgage-backed securities provisioned less for
bad loans. Also, Vyas (2009) constructs a novel measure of financial reporting transparency that
compares the timing of asset write-downs in U.S.

Vyas (2009) forms that during the period 2006-2008, the ultimate loan losses experienced by a
bank were anticipated in stock prices on a timelier basis for banks where the timing of asset
write-downs more closely matched the timing of changes in index prices in the context of
segment reporting, disclosures can be costly to managers in that they may face significant
personal costs from disclosing bad news to investors.

It was argued that problems inherent to accounting led to many poor and
uninformed investment decisions (Boer, 1994, Ray, 1960), and this fuelled
the public desire for information generated by companies to be subject to
greater regulation:
 Markets for information are not sufficient. Without regulation a sub-
optimal amount of information will be produced.
while proponents of the free-market approach may argue that the capital market on
average is efficient, such on average arguments ignore the rights of individual investors,
some of whom can lose their savings as a result of relying upon unregulated disclosures;
Those who demand information can often do so due to power over scarce resources.
Parties with limited power (limited resources) will generally be unable to secure
information about an organization, even though that organization may impact on their
lives;
Investors need protection from fraudulent organization that may
produce misleading information which due to information asymmetries,
cannot be known to be fraudulent when used (such as apparently
occurred at WorldCom in the USA and Parmalat in Italy);
Regulation emphasizes on uniformity and on comparability

Others argue that regulation is not necessary, particularly to the extent that
it currently exists. Some of the reasons cited include:

Accounting information is like any other good, and people (financial

statement users) will be prepared to pay for it to the extent that it has
use. This will lead to an optimal supply of information by entities.
Capital markets require information, and any organization that fails to
provide information will be punished by the market an absence of
information will be deemed to imply bad news.
Because users of financial information typically do not bear its cost of
production, regulation will lead to oversupply of information (at a cost
to the producing firms) as users will tend to overstate the need for the
information.
Regulation typically restricts the accounting methods that may be
used. This means that some organizations will be prohibited from using
accounting methods which they believe best reflect their particular
performance and position. This is considered to impact on the
efficiency with which the firm can inform the markets about its
operations.
It's costly for businesses - Regulation creates increased compliance costs for the business
with the need to engage expensive specifically trained personnel to regularly interpret and
apply the regulations to the financial affairs of a business, not to mention the costs of
audits and penalties that can apply.
Leuz and Schrand (2009) exploit the Enron scandal in 2001 as an exogenous shock to the
perceived precision and credibility of U.S. corporate reporting. They show that, in response to
this shock, firms increase their disclosures and that these (plausibly exogenous) disclosure
changes are in turn associated with subsequent declines in the cost of capital,as measured by beta
and another proxy for estimation risk. Again, there are also studies exploiting mandatory changes
in disclosure and reporting to illustrate a link between disclosure and the cost of capital (e.g.,
Shroff et al., 2013). Financial markets also respond to these events. For instance, the Enron
scandal reduced trust in financial reporting. It is likely that the ensuing skepticism led to
corporate responses attempting to assuage investor concerns (Leuz and Schrand, 2009) The
implication is that market reactions to the scandal and the effects of a regulatory change in
response to the event Thus, it is difficult to empirically separate the effects of the market
response from the regulatory effects.