An evaluation of “essays on disclosure” and the disclosure literature in accounting☆
Introduction
This is a critique of both Robert Verrecchia's “Essays on Disclosure” (henceforth, “Essays”) and the literature reviewed in Essays. In the following, I begin with a discussion of the origins and limitations of this critique. Following that, the critique presents a brief overview of what I regard as the central premise of the disclosure literature, and it then turns to a discussion of several conceptual issues involving the various models presented in Essays, with particular emphasis on those models dealing with the so-called “association-based disclosures”. Following this discussion, the critique offers an overall assessment of Essays. The critique concludes by offering an appraisal of recent trends in the disclosure literature.
I now describe briefly the origins and limitations of this critique. Regarding origins, my first critique of Essays was given at the April 2000 JAE conference. It was based on the February 2000 version of Essays circulated to all JAE conference participants. In response to those discussion comments, the suggestions of the Editors, and others, Verrecchia produced a revision of Essays dated July 2000. I wrote a detailed evaluation of this revised version of Essays, which was completed and circulated in September. The Editors gave Verrecchia the opportunity to revise Essays again to respond to my September critique. I received the third version of Essays in December 2000. The present critique thus constitutes my third review of some version of Essays.
The interaction between Verrecchia and me through these successive revisions and critiques of revisions has had some features akin to a well-argued debate. I think it is important for pedagogical, historical, and scholarly reasons for readers of Essays and this critique to get some sense of the dynamics of the evolution of these documents. Just as hearing only the closing arguments of a debate is a poor substitute for hearing a debate in its entirety, reading only the third version of Essays and a critique of that version is a poor substitute for reading the successive iterations of each of these documents. Ideally, the Editors of the JAE would publish all three versions of Essays, along with a transcript of my initial oral remarks (about the first version) and my comments on its various subsequent incarnations. Unfortunately, journal space constraints preclude this. In this third critique, I have tried to preserve some of the debate-like spirit of these interchanges while accommodating the constraints on journal space by presenting intact much of my second critique and then noting, to the best of my abilities, how the third version of Essays has been modified in response to my second critique.1
Revising my second critique so as to accomplish this goal while producing a readable document has required the adoption of several formatting conventions. The three iterations of Essays are referred to as V1, V2, and V3, with V3 being the published version, and V1 being the original February 2000 version. I generally relegate the changes of significance I identified in the successive iterations of Essays to footnotes at the appropriate places. To assist the reader in cross-referencing the quotations from Essays that appear in this critique with the published version of Essays (V3), I have replaced quotations from V2 with quotations from V3 whenever both documents contain either identical, or very similar, remarks. Where there are no changes, or only incidental changes, between V2 and V3, I typically make no comment about the absence of changes, with an occasional exception where I deem that an important criticism made about V2 remains unaddressed in V3.2
Whenever I quote from Essays, I label the version I am quoting. Given how the present version of the critique has evolved from my second critique of V2, when perusing the present document the reader should assume V2 is, by default, the document under discussion. Since V2 has circulated only in working paper form, and V1 was available only to JAE conference participants, I invite readers to ask Verrecchia for copies of V1 and V2 so as to verify that when I am quoting, paraphrasing, or summarizing V2 (or, exceptionally, V1), I am doing so accurately and in context.
Turning now to scope, the scope of this critique is limited in two respects. First, to the extent that this critique discusses individual papers mentioned in Essays, the discussion is generally restricted to what Essays itself states about the individual papers. This limitation should not prove to be problematic, since presumably Verrecchia chose to discuss what he considers to be the most salient sections of the papers he reviews. Second, I have attempted to confine all remarks in this critique to “high level” conceptual issues. In particular, this critique contains no evaluation of the many detailed arithmetical calculations contained in Essays. Since Essays contains many such calculations, this limitation in scope may seem considerable. But I have eschewed such analysis and commentary for three reasons: first, I have attempted to make this critique accessible to readers with only a passing acquaintance of Essays’ details. Second, the derivations in Essays are generally routine. Third, discussing details would detract from what I consider to be the more important, conceptual issues this critique raises.
Section snippets
The central premise of the disclosure literature
Nowhere in Essays is there a statement describing the central premises of the theory of disclosures, nor is it apparent upon reading the disparate models appearing in Essays that the models are organized around some common principle. Any “theory” worthy of the name consists of one or two general principles repeatedly applied, e.g., modern asset pricing merits the status of a theory, with its central organizing principle being that equilibrium in financial markets requires the equalization of
Association-based disclosures
In the first substantive section of Essays, Verrecchia studies what in V3 he calls “association-based disclosures” or what he called “disclosure association studies” (henceforth, “DAS”) in V1 and V2. DAS models are used to examine price, price reactions, and trading volume related to the introduction of new public information to market participants about some asset that has an unknown value. The basic set up is this: a public information release (referred to in the following alternatively as a
Discretionary-based disclosure
The analysis of the DAS models above pointed out the difficulties with taking disclosures as exogenously given. Essays also notes that, for a variety of reasons, developing endogenous models of disclosure is important.
Undoubtedly, the most important result regarding endogenous disclosures is the “full disclosure” or “unraveling” result of Grossman (1981), Grossman and Hart (1980), and Milgrom (1981). This result states, roughly, that if (1) the buyers of a product know that a seller has
Efficiency-based disclosure
In this section, Verrecchia illustrates how the selection among disclosure policies may require trading off reductions in the “cost of capital” obtained by making voluntary disclosures against the costs of unintentionally divulging proprietary information to a competitor through the firm's disclosures. Verrecchia calls disclosures that make these trade-offs optimally “efficient”, and the associated theory as one involving the “information asymmetry component of the cost of capital”. I applaud
An overall assessment of essays
In my oral discussion comments at the 2000 JAE conference, I proposed that a survey such as Essays should be judged by the following three criteria:
- 1.
Does the survey give its readers, particularly novices or others not familiar with the field, an overview of the field that highlights its central accomplishments? (Coverage)
- 2.
Is the survey insightful and offer perspective? I.e., does it “get under the hood” and explain how the results “work”? (Insight)
- 3.
Finally, is the survey bold about suggesting
Recent trends in the disclosure literature
Looking at the sweep of research on analytical models covered by this survey over the last 20 years, I have come to three general observations, all of which I find to be unfortunate. First, much of the literature has become computational rather than conceptual. That is, rather than articulating some new idea, much of the research has pursued the detailed working out of some known concept, e.g., what is the exact functional form of an earnings response coefficient in a linear rational
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2023, Journal of Accounting and EconomicsDisclosures about algorithmic decision making in the corporate reports of Western European companies
2023, International Journal of Accounting Information Systems
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This evaluation was prepared at the invitation of the editors of the Journal of Accounting and Economics for their Spring 2000 Conference. I wish to thank the editors for this opportunity and the Accounting Research Center at Northwestern University for financial support. I also want to thank Stephen Brown, Joel Demski, Mark Finn, Michael Fishman, Chandra Kanodia, Thomas Lys, Robert Magee, Sri Sridhar, Robert Verrecchia, Ross Watts, and Gregory Waymire for their comments on previous drafts of manuscript. Of course, all statements in this critique constitute my personal opinions. I visited the Goizueta Business School at Emory University while preparing the second draft of this critique. I wish to thank the Goizueta faculty and administration for their hospitality during my visit.