Financial Disclosure under Regulatory Fragmentation

Abstract

Regulatory fragmentation occurs when multiple regulatory bodies promulgate overlapping regulations. This overlap creates inconsistencies, inefficiencies, and unclear objectives but also results in enhanced domain specific scrutiny. Empirically, I find that regulatory fragmentation is associated with an increase in the discussion of uncertainty, litigation, and overall negativity in financial disclosures. The marginal effect of regulatory fragmentation is magnified with more exposure to agencies, especially enforcement agencies, as well as heightened levels of uncertainty and litigation. In response to the heightened uncertainty, I find that companies improve the quality of their textual disclosures and reduce accounting complexity, which is consistent with the informativeness view of financial reporting. At low levels of uncertainty and litigation risk, companies increase the readability of their text disclosures in response to regulatory fragmentation, but at high levels of uncertainty and litigation risk, companies increase the quantity of disclosure to the detriment of readability. Finally, at the time of earnings announcement the increase in bid-ask spreads is tempered by regulatory fragmentation, suggesting a reduction in information asymmetry from enhanced scrutiny. These results suggest that overlapping regulation may confer some degree of benefit to shareholders through the additional scrutiny from domain specific regulators, but that benefit must be weighed against the considerable costs to companies from regulatory fragmentation.

Keywords: Regulatory fragmentation, financial disclosure readability, accounting reporting complexity, government exposure

JEL Classification: G18, G38, H11, K22, M41, M48