Transparency as a Market Force: How Disclosure Reduces Economic Agency Costs

Agency costs arise when managers act in their own interest rather than in the interest of shareholders. In corporate economics, these costs reflect the inefficiencies that occur when information and incentives are misaligned. Disclosure, however, can act as a monitoring tool – one that reduces agency costs by increasing transparency and aligning management decisions with shareholder goals. Over the summer, I studied mandatory disclosure, more specifically the effect of a Nasdaq policy that stated companies could “comply or explain” with a gender and minority diversity requirement. Unlike a quota, this compliance was not necessarily enforced; rather, companies had to explain if they did not have a certain number of women or minorities on their boards. Although the legislation was eventually shut down, it made me think about the power disclosure can have on companies, whether that is for social good, environmental concerns, or investment information.

In my research, I came across an academic paper, Managerial Empire Building and Firm Disclosure, which tested the agency cost hypothesis in the context of geographic earnings disclosures. The hypothesis predicted that managers, when not monitored by shareholders, would make self-maximizing decisions – such as aggressively expanding the firm for profitability or geographic footholds – while ignoring firm value. Their findings supported this view, highlighting the important role of financial disclosures in monitoring managers and limiting such behavior. In today’s age of information and heightened demand for accountability, disclosure extends beyond financial reporting to ESG practices, wage transparency laws, and corporate social responsibility. Yet, this raises a critical question: How does disclosure reduce economic agency costs, and what are the broader implications of expanding disclosure requirements in an information-driven world?

Corporate transparency reduces information asymmetry between shareholders and managers—but at what point is a degree of asymmetry helpful or even necessary for markets and organizations to function? For example, disclosure of everything from strategy to technology could discourage innovation and risk-taking, eroding competitive advantage. In this article, I will explore how information disclosure shapes economic behavior: if all companies had to disclose information, such as salary and wages, how would that impact the economy and information symmetry? Would there be a net-positive effect? And what does our world look like without agency costs?

Disclosure vs. Mandates

Bhargav Gopal, an Economics professor at Queen’s, published a paper on How Do Firms Respond to Gender Quotas, which examined the impact of California’s SB8266, enacted in 2018 and requiring at least one female director on corporate boards by 2019, on financial performance and governance. The quota reduced the share of all-male boards by 24 percentage points without harming financial performance from 2018 to 2021. A quota, however, is a mandated or required outcome, which is a different approach than mandatory disclosure, which requires the disclosure of information. For example, Nasdaq’s mandated disclosure rule in 2021 stated firms either had to meet the diversity expectations, but if they did not, they simply had to explain why. Both policies led to increased board diversity, but disclosure was found to have no significant negative or positive impact on firm valuation. Disclosure proved to be a low-cost mechanism for improving social outcomes without disrupting market efficiency. Quotas on the other hand, proved to produce faster results, but raised concerns over tokenism and possible investor backlash. 

Why Not Disclose?

This made me curious: why might some resist disclosure? From a firm’s standpoint, full transparency carries risks. There is also a possibility of investor overreaction, which is exactly what it sounds like: markets misinterpreting disclosed data and creating volatility. 

Disclosure Economics and Agency Costs

Managerial Empire Building and Firm Disclosure also illuminates an interesting point – sometimes firms are more interested in building an empire than building long-term, sustainable, firm value for their shareholders. In the absence of disclosure, managers may hide unprofitable expansion behind aggregate numbers. Is that their right? Perhaps. But without disclosure in this case, there seems to be a form of deception taking place. Hope and Thomas examined the effect of discontinuing geographic earnings disclosure and found that firms that stop disclosing expand foreign operations more aggressively, while suffering lower foreign profit margins and lower firm values, relative to firms that continue disclosing. In this situation, agency costs were reduced by disclosure, but is this theory applicable in the grander scheme?

Recent Disclosure Developments

However, this theory is not a new concept, and disclosure has increased over time. Regulatory bodies like the Securities and Exchange Commission (SEC) have increasingly required companies to disclose more information about cybersecurity risks, executive pay, and climate-related risks. Investors are actively seeking more information beyond traditional financial metrics, because a lack of information is a lack of power – and with new tools to aid our research, not knowing a piece of information can be detrimental. The information standards have been raised. According to a 2024 Congressional Research Service report on SEC securities disclosure, as disclosure requirements and related costs have generally increased over time, questions have arisen over whether disclosed information is readable, as more information is being shared. For example, Walmart’s initial public offering (IPO) prospectus in 1970 totaled fewer than 30 pages, compared with Airbnb’s 202 IPO filing of more than 400 pages. 

With this substantial increase, what happens to the economy? What are the positives and what are the negatives? A 2006 Journal of Financial Economics study on non-U.S. firms cross-listing in the U.S. found that increased disclosure led to greater investor attention and trading activity—but also heightened volatility around earnings announcements, suggesting that transparency changes market behavior without guaranteeing stability.

In Support of Disclosure

In a 2011 paper, Does Enhanced Disclosure Really Reduce Agency Costs?, results from a study supported the premise that extensive disclosure impairs insiders’ abilities to utilize corporate resources in a self-serving manner. Firms with more disclosure practices see higher valuations on their cash assets and fewer value-destroying investments, suggesting that disclosure serves as a key check on managerial self-interest. 

So What?

Why, in this era, is agency cost so prevalent or not prevalent? Agency costs were initially defined by Michael Jensen and William Meckling in 1976. Although the desire to reduce self-interest has stayed the same, the way in which we do so has potential to drastically change. Artificial intelligence (AI) is now being considered as an effective corporate monitor, and certain AI mechanisms mitigate agency costs by enhancing governance quality through data transparency and limiting managerial discretion through algorithm-driven decision protocols. In terms of the SEC’s cybersecurity disclosure rules, there has been uncertainty. A petition letter cited key issues alleging that publicly disclosing cybersecurity incidents directly conflicts with confidential reporting requirements intended to protect critical infrastructure, create market confusion, and result in a net-loss. 

In this case, the concept of “market confusion” might be vague, and looking at the monetary value of reducing agency costs might be helpful. For example, The Agency Problem, Corporate Governance, and the Asymmetrical Behavior of SGA Costs, found the agency problem influences cost stickiness to a greater extent in mature firms and in firms where SG&A costs create low future value. Corporate governance was expected to reduce the agency problem. 

Conclusion

It is impossible to quantify the total annual money lost from agency costs globally. Overall, we want to trust the companies we invest in, buy from, or partner with. Studies have found that the simple act of disclosing sufficient information to shareholders, government, or the public can decrease agency costs and reduce self-serving decision-making within firms. In addition, there are societal benefits from disclosure that, as a whole, we are not maximizing. The act of disclosure requires minimal monetary investment, yet has the potential to reduce major economic inefficiencies.

Canada has extensive mandatory disclosure rules for tax, securities, and national security, while U.S. securities regulations and privacy laws like HIPAA also mandate broad information disclosure. For climate disclosure, the EU has introduced many mandates for companies, and China is considered a leader in sustainability disclosure. What can we learn from other countries going forward to improve disclosure policy, reduce agency costs, build trust, and strengthen our economies?