From Low-Quality Reporting to Financial Crises: Politics of Disclosure Regulation Along the Economic Cycle

Abstract

This paper examines how financial reporting regulations affect, and respond to, macroeconomic cycles by exploring a positive framework in which regulators subject to political pressures respond to cyclical demands by borrowers and lenders. We establish that, as economic conditions initially decline, political power shifts toward interest groups favoring less financial transparency. What follows is a counter-cyclical increase in economic activity, as more non-reporting loans are financed, possibly coincidental with more aggregate uncertainty. During a recession, reporting quality is increased, potentially causing a crisis-like adjustment of economic activity to the cycle. We discuss implications for procyclicality, event studies, bank lobbying, mark-to-market and cost of capital.

Keywords: Business Cycle, Regulation, Positive Economics, Political, Financial Crisis, Credit Market, Accounting Standards, Lobbying

JEL Classification: D2, D7, D8, D9, E3, E6, G2, G3, H1, K2, M1, M4