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E-MailAndrew Belnap is Assistant Professor of Accounting at the University of Texas at Austin McCombs School of Business. This post is based on his recent paper, forthcoming in the Journal of Accounting & Economics.
A fundamental factor in a firm’s disclosure choice is the extent to which market participants can process the information the firm discloses. Because market participants have limited attention and resources, they often rely on intermediaries to reduce processing costs by collecting, analyzing, and distributing firms’ disclosures and other information. By easing these frictions, intermediaries play a key role in capital markets and can significantly affect the cost-benefit equilibrium that firms face when making optimal disclosure decisions.
However, the ways in which intermediaries affect disclosure are relatively unexplored, in part due to several empirical challenges. First, intermediary coverage often occurs simultaneously with firm disclosure and other intermediaries’ coverage, making it difficult to isolate the effects of any one intermediary. Second, firm and disclosure characteristics typically drive intermediary coverage, introducing selection problems. Third, intermediaries often discuss multiple topics, making it difficult to isolate coverage of a particular disclosure.
In this paper, I examine the effect of coverage from two key intermediaries—non-governmental organizations (NGOs) and the media—on firms’ disclosure decisions. Specifically, I study whether coverage of a deficient disclosure can affect the targeted disclosure, how the disclosure changes, and why coverage affects the disclosure. To do this, I conduct a field experiment that, by randomizing intermediary coverage, can address the empirical challenges of this literature. In addition, I supplement the field experiment with a survey of tax executives, cross-sectional tests, and spillover tests that shed light on the roles played by stakeholders for which processing costs are reduced.
The effect of NGO and media coverage on disclosure is unclear. Because processing costs limit market participants’ benefit to consuming disclosure, a reduction in these costs can increase demand and drive up the supply of disclosure. It can also increase disclosure by raising the expected value of penalties that regulators and other stakeholders impose on firms for non-disclosure or insufficient disclosure. In contrast, reduced processing costs also make it easier for market participants to glean information from disclosures that can be used against the firm, thus increasing proprietary costs and leading to less disclosure. Finally, there is doubt that these intermediaries can affect disclosure at all to the extent they fail to reach key stakeholders or firms discount pressure from non-investor stakeholders.
To examine my research question, I identify a setting with high disclosure processing costs, and I partner with an NGO to organize a campaign that randomizes NGO and media coverage of a standalone tax disclosure. The setting I exploit is a new disclosure regime in the U.K. that requires firms to prepare a qualitative disclosure about their tax strategy and publish it online. Although the disclosures are public, processing costs are high because the law simply requires firms to publish the disclosure in any location on the internet, so long as it is free of charge and accessible to a member of the public. Hence, the cost for market participants to become aware of, acquire, and infer value implications is substantial. In fact, awareness costs appear to be sufficiently high to sustain an equilibrium with partial non-disclosure. A number of firms either do not initially publish the required disclosure or provide very low-quality disclosures, making it possible to examine the effect of intermediary coverage on non-disclosure and disclosure quality.
My empirical analysis includes the following. First, I conduct the field experiment by partnering with the Tax Justice Network (TJN) to produce a public report and organize a media campaign that targets two random sets of firms: firms that did not comply (“non-disclosing firms”) and firms that complied but had low-quality disclosures (“low-quality disclosure firms”). I then track firms’ disclosure behavior for six months. Although the campaign’s reach was relatively small and did not affect market returns, firms significantly changed their disclosures. By the end of the field experiment, 59 percent of treated non-disclosing firms begin disclosing, compared to 17 percent of control firms. Among low-quality disclosure firms, 7 percent of treated firms significantly improved their disclosures, compared to 0 percent of control firms.
Second, I examine the channels through which NGO and media coverage imposes pressure on firms using cross-sectional tests and a small sample of survey responses from tax executives. My findings suggest that the main results may be driven by firms perceiving pressure from the regulator (actual or anticipated), whose processing costs may have been reduced by the report. Firms also report pressure from the intermediaries themselves, as well as from external advisors and investors. In addition, external advisors such as accounting firms appear to have played an outsized role in contacting and advising firms on ex post disclosure choices.
Third, I analyze the content and timing of new disclosures provided by previously noncompliant treatment firms. Surprisingly, I find that these disclosures are on average lower in quality than disclosures from firms that initially complied, and that this result is driven by firms that responded more quickly. That is, although coverage from NGOs and the media has a large effect on firms’ compliance with mandatory disclosure, firms respond to the coverage by producing disclosures that are low quality. This finding suggests that firms’ disclosure responses to NGO and media coverage in many cases may be more symbolic gestures than substantial behavioral changes.
My paper contributes to a new and growing literature that examines how processing costs can affect firms’ disclosure, and it advances the literature on disclosure and taxes. My findings should be of interest to researchers and policymakers who increasingly turn to new public disclosure regimes to curb aggressive tax behavior and improve corporate transparency.
The complete paper is available for download here.
