Disclosure Policy and Enforcement: The Role of Corporate Boards

Abstract

The SEC holds corporate boards responsible for instituting proper controls to allay credibility concerns often associated with unaudited qualitative disclosures. In line with the SEC's stance on the board's role, we analyze a model in which the board (i) prescribes the firm's disclosure policy (a policy role), and (ii) chooses the extent to which it enforces compliance with the policy (a control role). The board's objective in our model is to balance profitability and a demand for information transparency from stakeholders, including shareholders, while contending with managerial incentives to inflate disclosures. We show that profitability concerns prompt a no-disclosure policy. However, the combination of profitability and transparency concerns induces the board to prescribe a pessimistic disclosure policy. Moreover, the board prefers a less pessimistic disclosure policy when it must contend with managerial incentives to inflate disclosures. Interestingly, the board exploits managerial incentives to inflate disclosures, which implies the board sometimes prefers to turn a ``blind eye'' to managerial over-reporting by being lax in enforcing compliance.

Keywords: Corporate Governance, Reporting Quality, Reporting Transparency, Disclosure Policy, Qualitative Disclosures, Disclosure Narrative

JEL Classification: G32, G38, L1, M41