That corporate transparency is a good thing is one of the givens of our age. On the principle that sunshine is the best disinfectant, companies have been required to prise open their books and make public a great deal of information that would once have been considered private.
Nor is this a static situation. In Europe, the thinking seems to be that if transparency is good, more transparency is even better. Disclosure obligations multiply and the day of the see-through corporation comes closer.
So enveloping is the pro-transparency consensus that it is a brave or perhaps foolish person who suggests there may be costs as well as benefits to prescriptive disclosure regimes. Yet my research shows this is indeed the case, that transparency can set up new incentives for firm behaviour and that the UK, once outside the European Union, may well wish to look at new approaches to corporate disclosure, especially in relation to small business.
But first, the case in favour of transparency. It often improves capital-market efficiency, giving investors a clear line of sight and allowing them to make better decisions. Indeed, it almost certainly increases the funds available for investment, given people and institutions are far more likely to put their money in businesses whose affairs are open than in opaque companies whose inner financial workings are a secret closely guarded by a cabal of directors.
In addition, transparency allows regulators and the media to identify corporate misbehaviours, such as tax avoidance, mis-selling, over-reliance on low-quality earnings, among others. Even when no wrongdoing is involved, mandatory disclosures can alert the outside world when a company is losing its way.
Finally, transparency can stimulate competition, because it identifies those products and sectors in which good profits are to be found, thus attracting new players whose arrival, in turn, lowers prices and improves standards.
So, there is widespread consensus on the benefits of corporate transparency. But a glance beyond Europe reveals wide variation in disclosure mandates, and far more scepticism about the desirability of transparency, particularly for small companies.
In the United States, there are practically no audit and disclosure requirements for small businesses, which are required to file little beyond their articles of incorporation. Canada is similar. At the far end of the spectrum, small businesses in France are subjected to a stack of disclosure regulations.
Britain will have a unique opportunity, outside the EU, to think long and hard about what is really required and beneficial in terms of corporate transparency and what is not. Such a period of reflection would need a full appreciation of the disbenefits of ever-more transparency as well as the benefits just mentioned.
One place to begin would be with the operation of the law of unintended consequences, of which a set-piece example would be the ready-mixed concrete industry in Denmark. In 1993, the country’s anti-trust authority, to stimulate competition in this sector, decided to collect and publish the prices charged by different firms across three regions of Denmark.
Classic transparency thinking would have expected prices either to stabilise or to fall, as customers rewarded the cheaper suppliers and the costlier ones were required to follow suit in order to maintain market share. In fact, the opposite occurred, with prices both converging and rising.
Why? Put simply, this illustrates how the effects of transparency vary depending on the structure of the industry concerned. Ready-mixed concrete companies compete in fairly narrow geographical areas, meaning new competition is unlikely to arrive from distant locations.
On top of this, fixed costs regard trucks, mixers and so forth, are high, so new entrants or expanding businesses require substantial investment.
As a result, the industry is already fairly concentrated, and price disclosure, far from spurring competition, allows for co-ordination among rivals.
"For post-Brexit Britain, all this adds up to opportunity. The place to start is an honest debate about disclosure"
But if the Danish concrete story is an example of transparency inadvertently curbing rather than spurring competition, other types of disclosures can lead to the type of competitive behaviour that many businesses deplore. Asked to select their biggest area of concern regarding mandatory disclosures, the top of private-firm managers’ list was that they did not wish competitors to learn of the company’s leverage – 42% gave this answer.
This came ahead of not wanting rivals to know about the company’s general performance (39.2%), not wanting customers or suppliers to see the company’s financial performance (32.7%) and not wanting neighbours, friends or family similarly to be aware of the company's financial performance (31.3%).
The answer that “it is time consuming to comply with such a law” came in fifth, with 29.8%.
As for the reasoning behind firms’ aversion to disclosing their leverage levels, the fear is that, once debt levels are publicly known, rivals will be able to engage in predatory market behaviour against those firms whose disclosures show them to be financially constrained. This behaviour can include deep price cuts or increased spending.
In the absence of such disclosures, predators would have faced much greater uncertainty as to the costs and benefits of making a move against the company in question. As it is, transparency gives the predator firm a good indication of whether or not its prey could survive even a relatively short price war or business downturn.
A classic case was seen in 2010, during the Great Recession, when Quidsi, parent company of Diapers.com, fell prey to Amazon, which cut its own price for diapers (nappies) by a third. Quidsi was unable to raise additional capital to continue the fight, so sold out to Amazon.
An inverse effect has been shown too: not only do firms like Amazon exploit rivals’ transparency, but sometimes transparency is used to undermine other firms. That disclosures are “weaponised” is likely little surprise to unionised firms that compete against non-unionised rivals. In cases where a unionised business is negotiating a new labour contract, non-unionised rivals have been found to disclose “good news” about its own operations, putting upward pressure on the likely wage bill facing its competitor.
“Britain will have a unique opportunity to think long and hard about what is really required and beneficial”
In light of all this, it is perhaps unsurprising that private firms take a sceptical view of the benefits of transparency. Asked how much net benefit they believed their company derives from the publication of their financial statements, 36.5% said that “the costs are larger than the benefits”, while 32.8% said that “the costs and benefits are approximately equal”.
Just 8.2% said that “the benefits are larger than the costs”.
Such a generally negative view of mandatory disclosures may help to explain the pattern of firm size in the UK. In 2018, my colleagues and I found businesses limit their size to stay below regulatory thresholds that impose income-statement disclosure and external audit.
This “bunching” effect is evident in other EU countries as well. And it appears largely due to incentives to avoid entanglement in compulsory transparency. As we note: “Our empirical estimates imply that at least 8% of firms that would otherwise be immediately above size thresholds manage size to avoid income-statement disclosure, a rate similar to or even greater than that to avoid mandatory audits.”
Collusion, market predation, “weaponised” disclosures, and artificial firm-size management: the charge sheet against transparency is lengthy and growing. The EU’s waffling on the mandated frequency of reporting for public companies indicates even it might question the value of boundless transparency.
Yet, as we have seen, there are clear benefits, in terms of market efficiency, the exposure of wrongdoing and the stimulation of competition.
Mergers and acquisitions, for example, can be more precisely calibrated as public information helps acquiring companies to make better choices, thus reducing the chances of the misallocation of capital. Recent work with colleagues generalises this point. We acquire data from Freedom of Information Act requests to observe companies acquiring information about other companies. We find that firms appear to access each other’s filings in large part to refine their investment and product decisions.
For post-Brexit Britain, all this adds up to opportunity. The place to start is an honest debate about disclosure, not captured by the religion of transparency. Special reference is due to smaller businesses. Even better if the conversation recognises the role of factors like industry structure in determining how disclosure affects outcomes.
We should hope that politicians see real choice: a US-style regime of few mandatory disclosures, or the much more prescriptive approach common in the EU. Fair warning that the proponents of the former will need to be brave. Or perhaps a bit foolish.