Academic journal article Law and Contemporary Problems

Required Disclosure and Corporate Governance

Academic journal article Law and Contemporary Problems

Required Disclosure and Corporate Governance

Article excerpt

MERRITT B. Fox [*]

I

INTRODUCTION

One of the most distinctive features of U.S. business law is the stringent requirements of ongoing disclosure imposed on issuers of publicly traded securities. [1] This scheme usually has been justified as necessary to protect investors from making poor trading decisions as a result of being uninformed. Little scholarly attention, however, has been paid to the corporate governance effects of such required disclosure. [2] In analyzing these effects, this article concludes that required disclosure can improve corporate governance in important ways. Indeed, improving corporate governance, not investor protection, provides the most persuasive justification for imposing on issuers the obligation to provide ongoing disclosure.

Before delving further into this topic, it is important to define more precisely the terms "required disclosure" and "corporate governance." "Required disclosure," as used in this article, means any legal obligation that requires an issuer's management to provide, on a regular basis, information that it otherwise might not be inclined to provide. [3] In the United States, the primary source of required disclosure is the periodic disclosure requirements imposed on publicly traded companies under the Securities and Exchange Act of 1934 ("Exchange Act"). [4] Other sources of required disclosure include the law of the issuer's state of incorporation, the rules of the stock exchange on which the is [5] suer's shares are listed, and the issuer s articles of incorporation. The term "corporate governance" refers to the myriad mechanisms that shape the structure of incentives, disincentives, and prohibitions under which an issuer's management makes decisions.

This inquiry will be confined in two respects. First, while disclosure can influence corporate governance in ways that impact a variety of interests--including labor, environmental quality, and the local community in which the issuer operates--the focus here will be exclusively on shareholder welfare. Second, the concern here is with the corporate governance of established issuers with shares actively trading in a public market and without a control shareholder or shareholder group.

II

CORPORATE GOVERNANCE AS THE CENTRAL JUSTIFICATION FOR REQUIRED DISCLOSURE

Required disclosure usually is justified as a way of providing investors buying and selling in the secondary market with protection comparable to what investors buying in the primary market receive through new issue registration disclosure. Contrary to popular belief, however, the main social benefit of required disclosure is its influence on corporate governance. [6] Investor protection is a worthy goal of securities legislation, but it is not a persuasive justification for the affirmative regulation of issuer disclosure. [7] Disclosure is not necessary to protect investors against either unfair prices or risk.

First, consider unfair prices. Under the efficient market hypothesis, security prices are unbiased, regardless of the amount of publicly available information about an issuer. [8] In other words, share prices, on average, equal the actual value of the shares involved regardless of whether issuers are required to produce substantial or minimal disclosure. Thus, greater disclosure is not necessary to protect investors from purchasing shares at prices that are, on average, unfair or higher than their actual values. [9]

Next, consider risk. With less available information about an issuer, the share price, while still unbiased, is less accurate; that is, the price is more likely to be significantly above or below the share's actual value. If an investor has a less-than-fully-diversified portfolio, greater share-price inaccuracy can make her portfolio more risky. High-quality disclosure, to some extent, would protect such an investor by reducing this risk. However, the investor can protect herself much more effectively and at less social cost by simply diversifying more. …

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