Transparency and Corporate Governance∗

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. ∗The authors thank seminar and conference participants at the University of California, the University of Chicago Law School, the University of Illinois, La Trobe University (Bundoora), the London Business School, the University of Queensland, RMIT, the Swedish Institute for Financial Research Conference, Stockholm, the Olin Business School’s Second Annual Conference on Corporate Governance, the Stanford Accounting Conference, the 2006 FRA Conference, and the 2007 ASSA Meetings. The authors are grateful to Philip Bond, Christian Leuz, Roberta Romano, Jeroen Swinkels, and, especially, Denis Gromb and Jeff Zwiebel for their comments and suggestions. †Thomas and Alison Schneider Distinguished Professor of Finance. Contact information — Phone: (510) 642-7575. E-mail: [email protected]. Full address: University of California • Walter A. Haas School of Business • 545 Student Services Bldg. #1900 • Berkeley, CA 94720-1900. ‡Stanley C. and Joan J. Golder Distinguished Chair in Finance. Contact information — Phone: (217) 265-0258. E-mail: [email protected]. Full address: University Of Illinois • 340 Wohlers Hall • 1206 S. Sixth Street • Champaign, IL 61820. Copyright c © 2007 by Benjamin E. Hermalin & Michael S. Weisbach. All rights reserved. Hermalin and Weisbach Introduction 1