Why is Financial Reporting so Inefficient? *

Abstract

Those who know do not tell; those who tell do not know. Lao Tse

In earlier papers (Hakansson, 1977, 1981), the equilibrium properties of two financial disclosure scenarios, “laissez-faire” and “timely public disclosure” were compared. The analysis showed that, measured in welfare space, the incentives of only two groups, less well-to-do subscribing investors and nonsubscribing investors (who tend to be “small” in terms of their resources) prefer the second scenario even though it results in greater aggregate output across states. The incentives of management, information searchers, and more well-to-do investors favor a “wide window” between significant events affecting the firm and their public disclosure, at least in the short run. The “cost” of this scenario is that it draws a sizable group of talented people from the productive sector into “scooping” information before its eventual disclosure. It is noteworthy that a regulatory solution is likely to further reduce, not improve, the productive efficiency of the economy.

This paper examines the financial disclosure question further and argues that its resolution is directly linked to the principal-agent “contract” between the shareholders and management. These contracts do exhibit some peculiar properties, especially in the area of management compensation and with respect to MBOs, in which management apparently manages to be both the buyer and the “agent” for the seller.