A New Light on Public Company Spending Disclosure

The following post comes to us from Michael D. Guttentag, Professor of Law at Loyola Law School in Los Angeles. It is based on his recent paper, “A New Light on Public Company Spending Disclosure,” which is forthcoming in The Columbia Business Law Review and is available here.

In “A New Light on Public Company Political Spending Disclosure” I reach the surprising conclusion, based, in part, on previously unpublished empirical findings, that public companies should not be required to disclose political spending.

Why is this conclusion surprising? Because there are so many alluring justifications for requiring public companies to disclose their political spending. On first glance, political spending information appears to be quite similar to much of the information public companies are already required to disclose. One might also assume that access to information about political spending is a necessary prerequisite for shareholders to exercise basic rights as the firm’s owners. Finally, there is evidence suggesting: 1) that private ordering alone does not lead public firms to adopt socially optimal disclosure policies, 2) that weak corporate governance is associated with higher levels of political spending, and 3) that for firms which are less transparent about political spending there is a measureable uptick in the negative relationship between political spending and future poor stock performance. These arguments and the related evidence explain the unprecedented (although not universal) support for a political spending disclosure requirement.

However, many of these arguments for requiring public companies to disclose their political spending do not hold up to careful scrutiny. For example, an argument based on similarities between political spending and other information firms are already required to disclose places unwarranted reliance on the efficacy of current disclosure policies and ignores similarities between political spending and information public companies are not required to disclose. Similarly, the argument that mandatory political spending disclosure is necessary to protect shareholder rights fails to explain why voluntary mechanisms do not already provide the necessary protection to concerned investors.

More fundamentally, the debate about whether the SEC should require the disclosure of political spending by public companies reveals general confusion and disagreement about precisely how to determine what public companies are required to disclose. In this article I first answer the more general question of how to evaluate any proposed public company mandatory disclosure requirement, and then use this answer to address the specific question of whether political spending disclosure should be required.

Based on this approach, I come to my surprising conclusion based on the following logic. As a starting point, I identify three reasons why imposing on public firms even seemingly minimal topic-specific disclosure requirements is rarely harmless. First, especially with changes enacted as part of the JOBS Act, for many firms it is now easy and palatable to remain outside of the public company reporting regime. Unnecessary disclosure requirements may simply provide a subsidy to firms that choose to avoid or exit the public disclosure regime. Second, the cost of even the best-designed one-size fits all disclosure requirement is likely to be significant, because public firms are such a strikingly diverse group. Third, any disclosure obligation, once imposed, is likely to remain in place, even if ineffective, for no other reason than administrative inertia. Ideally, it would be feasible to experiment with the introduction of new disclosure obligations and then remove them, if the resulting evidence showed that the costs of the disclosure obligation exceeded the benefits. However, our disclosure system is not yet that facile.

What evidence should be sufficient to overcome this presumption against imposing a new topic-specific disclosure requirement? The scholarship on disclosure regulation identifies only two market failures that justify regulating public company disclosures: 1) positive externalities from these disclosures, and 2) the adoption of opaque disclosure policies by firm insiders to facilitate tunneling. Evidence of significant distortions caused by either of these market failures could be sufficient to overcome the presumption against imposing a new topic-specific disclosure requirement. But such evidence does not yet exist with respect to public company political spending.

Positive externalities may lead public firms to systematically underdisclose political spending, and not all public firms elect to disclose political spending. But the trivially small dollar amounts involved in political spending provides the better explanation of non-disclosure of political spending by many firms. There is one caveat before dismissing entirely a positive externalities market failure justification for requiring the disclosure of political spending. Even though the amounts involved in political spending by public companies are trivially small, political spending disclosure does provide statistically significant information about the future performance of a firm’s securities. One might argue that the non-disclosure of this information, despite its apparent usefulness in pricing the firm’s securities, is evidence of a positive externality market failure. But the evidence also shows that political spending is value relevant because it provides an informative signal about otherwise unobservable firm attributes, rather than because it actually causes a future decline in firm value. Mandating the disclosure of an informative signal is not likely to benefit shareholders, even in the event (unlikely here) that the signal was withheld because of positive externalities.

Underdisclosure by firm insiders to facilitate tunneling is the second market failure that can provide an economic justification for mandating the disclosure of certain information. There are some indications that political spending may constitute tunneling by firm insiders. There is a high correlation between the political beliefs supported by the firm and those held by the firm’s CEO, and higher levels of political spending are observed at firms where the amount of tunneling overall is higher. However, correlation does not imply causation, and there are many plausible explanations for these correlations other than self-serving political spending by firm insiders. More importantly, there is little reason to expect that mandating disclosure of political spending would provide a cost-effective means to deter wasteful political spending, even if it is occurring. Previously unpublished findings from research by Rajesh Aggarwal and his colleagues suggest that the link they uncover between more political spending disclosure and less tunneling is probably indicative of a signaling effect rather than of a causal link that could justify requiring political spending disclosure based on deterrence gains.

In summary, the argument for the mandatory disclosure of political spending, while initially appealing, does not stand up to more careful scrutiny.