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Cited by 6Corporate Finance and GovernanceAuditing, Earnings Management, GovernanceCorporate Governance and Financial Management

Transparency and corporate governance

Open access
Hermalin, Benjamin E.·2014·Enterprise Law
DOI 10.4337/9781781004456.00032
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Abstract

An objective of many proposed corporate governance reforms is increased transparency. This goal has been relatively uncontroversial, as most observers believe increased transparency to be unambiguously good. We argue that, from a corporate governance perspective, there are likely to be both costs and benefits to increased transparency, leading to an optimum level beyond which increasing transparency lowers profits. This result holds even when there is no direct cost of increasing transparency and no issue of revealing information to regulators or product-market rivals. We show that reforms that seek to increase transparency can reduce firm profits, raise executive compensation, and inefficiently increase the rate of CEO turnover. We further consider the possibility that executives will take actions to distort information. We show that executives could have incentives, due to career concerns, to increase transparency and that increases in penalties for distorting information can be profit reducing.

Integrity signals

Registry

Crossref · 10.4337/9781781004456.00032

Cites

22 of 22 references verified0 citation errors · 0 not checkable

Statistics

Nothing to recompute.

Claims the paper makes

0 of 8 cited sources checked · 0 supported · 0 flagged

  • Findingown data

    When the model is calibrated to reflect actual publicly traded large US corporations, the parameters implied by the calibration lead to a finite value for optimal disclosure quality.

    “When we calibrate the model to reflect actual publicly traded large us corporations, we find that the parameters implied by the calibration lead to a finite value for optimal disclosure quality.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO is risk averse.
    • The authors state this as an assumption: There is a second-period market for the CEO's services, with γ > 0.
    • The authors state this as an assumption: The CEO has career concerns and is concerned about information transmittal to the broader market.
  • Findingreasoning

    If the profit-maximizing level of reporting is finite, then regulations that force the firm to adopt higher reporting levels will reduce expected profits.

    “Corollary 1 If the profit-maximizing level of reporting is finite, then regulations that force the firm to adopt higher reporting levels will reduce expected profits, raise ceo compensation, and increase the probability of ceo dismissal.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO is risk averse.
    • The authors state this as an assumption: There is a second-period market for the CEO's services, with γ > 0.
    • The authors state this as an assumption: The CEO has career concerns and is concerned about information transmittal to the broader market.
  • Findingnone given

    The marginal benefit of Q is unaffected by a change in γ.

    “The marginal benefit of Q is unaffected by a change in γ.”
    Quote in the paperNot a substantial claim
  • Findingnone given

    If the profit-maximizing level of reporting quality q is an interior maximum, then q is strictly decreasing in the firing cost f.

    “Proposition 2 If the profit-maximizing level of reporting quality, q, is an interior maximum, then the following comparative statics hold: (i) The profit-maximizing level of the quality of reporting, q, is strictly decreasing in the firing cost, f .”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: Firing costs f are non-negative.
  • Findingreasoning

    There exists a finite value r*, a function of the parameters, such that if r > r*, the CEO engages in no efforts at exaggeration in equilibrium.

    “Moreover, there exists a finite value r * , a function of the parameters, such that, if r > r * , the ceo engages in no efforts at exaggeration in equilibrium.”
    Quote in the paperSubstantial claim
  • May combine two claims. 20
  • The quote only partly states this claim. 2
  • Classified as probably not a substantial claim. 8

  • May combine two claims. The quote only partly states this claim.

    Findingreasoning

    If the CEO's coefficient of absolute risk aversion is non-increasing, then the CEO's efforts to exaggerate performance are non-decreasing in the importance of his second-period labor market (γ), and strictly increasing if x_e > 0.

    “(ii) the ceo's efforts to exaggerate performance are non-decreasing in the importance of his second-period labor market (i.e., γ) and strictly increasing if x e > 0;”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO's coefficient of absolute risk aversion is non-increasing.

  • May combine two claims.

    Findingreasoning

    In the calibration, the optimal q is approximately 1.684 × 10^-14; that is, the standard deviation on reporting quality is $7.71 million.

    “Indeed, the optimal q proves to be approximately 1.684 × 10 -14 ; that is, the standard deviation on reporting quality is $7.71 million.”
    Quote in the paperNot a substantial claim

  • Probably not a substantial claim: may not pass S4 (based).

    Findingnone given

    The marginal cost of Q (equivalently, q) is increasing in γ.

    “Because the marginal cost of Q (equivalently, q) is increasing in γ, the result follows.”
    Quote in the paperNot a substantial claim

  • May combine two claims.

    Findingreasoning

    Better transparency is not free: the better able the market is to learn about the CEO's ability, the greater the risk to which the CEO is exposed.

    “But better transparency is not free: The better able the market is to learn about the ceo's ability, the greater the risk to which the ceo is exposed.”
    Quote in the paperSubstantial claim

  • May combine two claims.

    Findingown data

    Using the calibration values, the right-hand side of equation (8) is approximately 3.279; hence, the firm would optimally choose a finite level of reporting quality.

    “Using these values, the right-hand side of ( 8) is approximately 3.279; hence, the firm would optimally choose a finite level of reporting quality.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO is risk averse.
    • The authors state this as an assumption: There is a second-period market for the CEO's services, with γ > 0.
    • The authors state this as an assumption: The CEO has career concerns and is concerned about information transmittal to the broader market.

  • Probably not a substantial claim: may not pass S1 (asserted), S3 (load-bearing), S4 (based).

    Findingnone given

    Given that u(•) is L2 for any normal distribution, it follows that u'(•) is L1 for any normal distribution; that is, E{u'(z)} exists (is finite) if z is distributed normally.

    “Lemma A.1 Given that u(•) is L 2 for any normal distribution, it follows that u (•) is L for any normal distribution; that is, that E{u (z)} exists (is finite) if z is distributed normally.”
    Quote in the paperNot a substantial claim

  • May combine two claims.

    Findingreasoning

    Regardless of the coefficient of absolute risk aversion, the CEO's efforts to exaggerate performance are non-increasing in the marginal penalty r for engaging in these efforts, and strictly decreasing if x_e > 0.

    “Regardless of the coefficient of absolute risk aversion, (iv) the ceo's efforts to exaggerate performance are non-increasing in the marginal penalty (i.e., r) for engaging in these efforts and strictly decreasing if x e > 0.”
    Quote in the paperSubstantial claim

  • The quote only partly states this claim.

    Findingreasoning

    If the CEO's coefficient of absolute risk aversion is non-increasing, then the CEO's efforts to exaggerate performance are non-increasing in the precision of the prior estimate of CEO ability (τ), and strictly decreasing if x_e > 0.

    “(iii) the ceo's efforts to exaggerate performance are non-increasing in the precision of the prior estimate of ceo ability (i.e., τ ) and strictly decreasing if x e > 0.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO's coefficient of absolute risk aversion is non-increasing.

  • May combine two claims.

    Findingnone given

    Parameter values exist such that q → ∞ is optimal, as do values such that q = 0 is optimal.

    “Parameter values exist such that q → ∞ is optimal, as do values such that q = 0 is optimal.”
    Quote in the paperNot a substantial claim

  • Probably not a substantial claim: may not pass S3 (load-bearing). May combine two claims.

    Premisecitation

    Commentators typically focus on the direct costs of disclosure, as well as the competitive costs arising because the disclosure provides potentially useful information to product-market rivals.

    “To offset this benefit, commentators typically focus on the direct costs of disclosure, as well as the competitive costs arising because the disclosure provides potentially useful information to product-market rivals.”
    Quote in the paperNot a substantial claim0 of 3 sources checked
    • cites Leuz and Wysocki (2006)

      Couldn’t be matched to a paper in Crossref, so it can’t be checked.

    • cites Feltham et al. (1992)

      Couldn’t be matched to a paper in Crossref, so it can’t be checked.

    • cites Hayes and Lundholm (1996)

      Couldn’t be matched to a paper in Crossref, so it can’t be checked.

  • May combine two claims.

    Interpretationown data

    Disclosure requirements going beyond the optimal level are likely to have unintended consequences and to reduce value.

    “Thus, our analysis suggests that disclosure requirements going beyond this optimal level are likely to have unintended consequences and to reduce value.”
    Quote in the paperSubstantial claim

  • May combine two claims.

    Interpretationreasoning

    Through its impact on corporate governance, higher quality disclosure both provides benefits and imposes costs.

    “Through its impact on corporate governance, higher quality disclosure both provides benefits and imposes costs.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO is risk averse.
    • The authors state this as an assumption: There is a second-period market for the CEO's services, with γ > 0.
    • The authors state this as an assumption: The CEO has career concerns and is concerned about information transmittal to the broader market.

  • Probably not a substantial claim: may not pass S3 (load-bearing). May combine two claims.

    Premisecitation

    The most commonly discussed benefit of transparency is that it reduces asymmetric information, and hence lowers the cost of trading the firm's securities and the firm's cost of capital.

    “The most commonly discussed benefit of transparency is that it reduces asymmetric information, and hence lowers the cost of trading the firm's securities and the firm's cost of capital.”
    Quote in the paperNot a substantial claim0 of 2 sources checked
    • cites Diamond and Verrecchia (1991) source
    • cites Leuz and Verrecchia (2000) source

  • May combine two claims.

    Interpretationreasoning

    Reporting quality should be better with older (lower γ) or better known (greater τ) CEOs, ceteris paribus.

    “Proposition 2 also suggests that, ceteris paribus, reporting quality should be better with older (lower γ) or better known (greater τ ) ceos.”
    Quote in the paperSubstantial claim

  • Probably not a substantial claim: may not pass S3 (load-bearing), S4 (based).

    Study design and conductnone given

    The paper's substantive results are robust to allowing the level of transparency to be set through a bargaining process in which the CEO has bargaining power.

    “We could have alternatively allowed for the level of transparency to be set through a bargaining process in which the ceo has bargaining power.Our substantive results are robust to such a change.”
    Quote in the paperNot a substantial claim

  • May combine two claims.

    Interpretationreasoning

    An increase in the firing cost lowers the marginal return to reporting quality without affecting the marginal cost of reporting quality, so the equilibrium value of reporting quality falls if disruption costs rise.

    “Intuitively, an increase in the firing cost lowers the marginal return to reporting quality, without affecting the marginal cost of reporting quality (i.e., the distribution of w 2 ); hence, the equilibrium value of reporting quality falls if disruption costs rise (except if the optimal reporting quality is zero or, possibly, if it is infinite).”
    Quote in the paperSubstantial claim

  • May combine two claims.

    Interpretationreasoning

    The pattern of CEO salaries and turnover is consistent with the model and with the idea that better information has both costs and benefits through its impact on corporate governance.

    “This pattern of ceo salaries and turnover is consistent with our model; moreover, it is consistent with the idea that better information has both costs and benefits through its impact on corporate governance.”
    Quote in the paperSubstantial claim

  • Probably not a substantial claim: may not pass S3 (load-bearing), S4 (based).

    Interpretationnone given

    The model can equally well be applied to direct monitoring by shareholders.

    “One could equally well apply it to direct monitoring by shareholders.”
    Quote in the paperNot a substantial claim

  • May combine two claims.

    Premisecitation

    Both CEO salaries and CEO turnover have increased substantially starting in the 1990s, with at least some scholars attributing the increase to higher press scrutiny and investor activism.

    “In fact, both ceo salaries and ceo turnover have increased substantially starting in the 1990s, with at least some scholars' attributing the increase to the higher level of press scrutiny and investor activism (see Kaplan and Minton, 2006).”
    Quote in the paperSubstantial claim0 of 1 sources checked
    • cites Kaplan and Minton, 2006

      Couldn’t be matched to a paper in Crossref, so it can’t be checked.

  • May combine two claims.

    Interpretationreasoning

    The model contains clear empirical predictions: consequences of improved information would be increases in CEO salaries and the rate of CEO turnover.

    “In particular, it suggests that consequences of improved information would be increases in ceo salaries and the rate of ceo turnover.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: All other things equal, better information disclosure increases firm value.

  • Probably not a substantial claim: may not pass S3 (load-bearing). May combine two claims.

    Premisecitation

    Long-serving CEOs can develop bargaining power vis-à-vis the board and can use this power to bargain for less intense monitoring.

    “Another confounding factor is that long-serving ceos can develop bargaining power vis-à-vis the board and they can use this power to bargain for less intense monitoring (see Hermalin and Weisbach, 1998).”
    Quote in the paperNot a substantial claim0 of 1 sources checked
    • cites Hermalin and Weisbach, 1998

      Couldn’t be matched to a paper in Crossref, so it can’t be checked.

  • May combine two claims.

    Interpretationreasoning

    The greater the importance of the second-period market γ, or the more diffuse the prior beliefs (lower τ), the greater the effective risk aversion of the CEO and the more we should expect a finite level of reporting quality to be optimal.

    “Observe that the greater the importance of the second period market, γ, or the more diffuse the prior beliefs (i.e., the lower is τ ), the greater the effective risk aversion of the ceo and, thus, the more we should expect a finite level of reporting quality to be optimal.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The CEO is risk averse.
    • The authors state this as an assumption: There is a second-period market for the CEO's services, with γ > 0.

  • May combine two claims.

    Interpretationreasoning

    The directors set the level of transparency (e.g., amount and quality of disclosure), and it is part of an endogenously chosen governance arrangement.

    “The directors set the level of transparency (e.g., amount and quality of disclosure) and it is, thus, part of an endogenously chosen governance arrangement.”
    Quote in the paperSubstantial claim
    • The authors state this as an assumption: The board is perfectly aligned with shareholders' interests.

  • May combine two claims.

    Interpretationreasoning

    An increase in γ raises the marginal cost of reporting quality but leaves the marginal benefit untouched.

    “It can be shown that an increase in the importance placed on the signal by the ceo in terms of his second-period salary (i.e., an increase in γ) raises the marginal cost of reporting quality (i.e., dw 1 /dq increases in γ), but leaves the marginal benefit untouched.”
    Quote in the paperSubstantial claim

  • May combine two claims.

    Interpretationreasoning

    Increasing transparency provides benefits to the firm but entails costs as well.

    “Increasing transparency provides benefits to the firm, but entails costs as well.”
    Quote in the paperSubstantial claim

  • Probably not a substantial claim: may not pass S3 (load-bearing), S4 (based).

    Study design and conductreasoning

    Nothing relies critically on the assumption that the CEO is hired in Stage 1.

    “Although we assume the ceo is hired in Stage 1, it should be clear that nothing relies critically on this assumption.”
    Quote in the paperNot a substantial claim
    • The authors state this as an assumption: The CEO is hired in Stage 1.
26 of 26

  • The authors state this as an assumption.

    The CEO is risk averse.

    “In our analysis, we assume the ceo is risk averse.”

  • The authors state this as an assumption.

    There is a second-period market for the CEO's services, with γ > 0.

    “Assume, too, that the contribution of a ceo of ability α to a future employer is γα + δ, where γ > 0 and δ are known constants.”

  • The authors state this as an assumption.

    The CEO has career concerns and is concerned about information transmittal to the broader market.

    “The ceo has career concerns, so he is concerned about information transmittal to the broader market.”

  • The authors state this as an assumption.

    The owners are risk neutral.

    “Assume that the owners are risk neutral.”

  • The authors state this as an assumption.

    The public signal s is normally distributed with mean equal to CEO ability α and variance 1/q.

    “The signal is distributed normally with a mean equal to α and a variance equal to 1/q.”

  • The authors state this as an assumption.

    A CEO's ability is fixed throughout his career.

    “A ceo's ability is fixed throughout his career.”

  • The authors state this as an assumption.

    The CEO and potential employers know only the distribution of his ability, not his actual ability.

    “We follow Holmstrom (1999) by assuming that the ceo, like all other players, knows only the distribution of his ability.”

  • The authors state this as an assumption.

    The owners make a take-it-or-leave-it offer to the CEO.

    “Assume the owners make a take-itor-leave-it offer to the ceo.”

  • The authors state this as an assumption.

    The firm cannot escape its salary obligation to the initial CEO.

    “We assume that the firm cannot escape its salary obligation to the initial ceo”

  • The authors state this as an assumption.

    Firing costs f are non-negative.

    “The amount, f , which is assumed to be non-negative, reflects the costs associated with dismissing the initial ceo (firing costs).”

  • The authors state this as an assumption.

    The CEO finds distortion efforts costly.

    “We assume that the ceo finds these efforts costly.”

  • The authors state this as an assumption.

    The board relies on the same information that is released to the public in making its monitoring decisions.

    “One key assumption we make throughout the paper is that the board relies on the same information that is released to the public in making its monitoring decisions.”

  • The authors state this as an assumption.

    The board is perfectly aligned with shareholders' interests.

    “Our model is set in the context of a board that is perfectly aligned with shareholders' interests.”

  • The authors state this as an assumption.

    Neither kind of effort has a positive impact on profits.

    “We assume that neither kind of effort has a positive impact on profits.”

  • The authors state this as an assumption.

    The signal observed by owners and outsiders is s = s + x.

    “We assume that the signal observed by owners and outsiders is s = s + x.”

  • The authors state this as an assumption.

    The CEO's coefficient of absolute risk aversion is non-increasing.

    “Assuming the coefficient of absolute risk aversion to be non-increasing rules out that possibility.”

  • The paper relies on this without support.

    The logic of how transparency potentially affects governance is absent from the academic literature.

    “The logic of how transparency potentially affects governance is absent from the academic literature.”

  • The authors state this as an assumption.

    All other things equal, better information disclosure increases firm value.

    “We emphasize that these effects occur in a model in which all other things equal, better information disclosure increases firm value.”

  • The authors state this as an assumption.

    The CEO is hired in Stage 1.

    “Although we assume the ceo is hired in Stage 1, it should be clear that nothing relies critically on this assumption.”

  • The authors state this as an assumption.

    The owners make a take-it-or-leave-it offer.

    “Because the owners make a take-it-or-leave-it offer and their well-being is decreasing in w 1 , the constraint above must bind.”

  • The authors state this as an assumption.

    The precision of the signal is (1-b)q, where b is efforts at obscuring the signal.

    “Let the precision of the signal be (1b)q, where b is efforts at obscuring the signal.”

  • The authors state this as an assumption.

    The cost function satisfies lim |b|→1 c(|b|) = ∞.

    “Assume lim |b|→1 c |b| = ∞.”
22 of 22

Self-check

Percentages, sums and reported differences re-computed from the paper’s own numbers.

Each contradiction between two passages listed here was confirmed by an independent check.

  • Claimed risk-neutral limit does not exist as stated

    Minor

    As ρ approaches zero from above, the displayed utility function tends to negative infinity, not w. Subtracting a diverging constant could produce a normalized risk-neutral limit, but the paper does not do that here.

  • Normal-moment variance term is twice its correct value

    Minor

    For a normal variable with variance σ2, the variance term in E[exp(-2ρw)] is (2ρ)2σ2/2 = 2ρ2σ2, not 4ρ2σ2.

    Reported 4 · recomputed 2

  • Calibration assigns the reservation utility the wrong sign

    Minor

    The stated utility function is negative for positive ρ, so earning $500,000 in each period gives a negative reservation utility. The calibration instead assigns it a positive value; with that value, the stated expression for profit is not real-valued.

3 of 3

Cites

Flagged first, then by citations

5 of the 27 references couldn’t be matched to a known paper.

Research works printed but not linked: 1

  1. [11]11. Avery W. Katz, and Richard Craswell, "Contract Law," in A. Mitchell Polinsky and Steven Shavell, eds., Handbook of Law and Economics, Vol. 1 in press.

Cited by

Sorted by citations

Related

Authors
Hermalin, B. E.
Affiliations
National Bureau of Economic Research (US)
Corresponding author
Hermalin, Benjamin E.
Venue
Enterprise Law
Publisher
Edward Elgar Publishing
Published
2014-08-29
DOI
10.4337/9781781004456.00032
OpenAlex
W3150449259
Cited by
6
References
27
Citations by year
2024: 1 · 2023: 3 · 2021: 2
FWCI
0.00
Type
book chapter
Language
en
Open access
Locations
Edward Elgar Publishing eBooks (publishedVersion)
Topics
  • Social Sciences › Business, Management and Accounting › Accounting › Corporate Finance and Governance
  • Social Sciences › Business, Management and Accounting › Accounting › Auditing, Earnings Management, Governance
  • Social Sciences › Business, Management and Accounting › Strategy and Management › Corporate Governance and Financial Management
Keywords
corporate transparency, corporate governance reform, firm profitability, executive compensation, CEO turnover, information distortion, career concerns

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