Governance Mechanisms and Corporate Disclosure∗

This paper explores a firm’s reliance on internal and external governance mechanisms as part of the firm’s overall governance policy. We argue that firms’ disclosure policies, by promoting greater transparency, foster external scrutiny and thus activity in the market for corporate control. Takeovers and internal board monitoring are therefore substitute instruments for corporate governance. However, agency problems between the board and shareholders can lead to inefficient levels of both monitoring and disclosure. In this context, technological progress which increases the returns to information acquisition and reduces the cost of disclosure can diminish the cost of such inefficiencies. We show that improvements in dissemination technology lead to more disclosure and improved external governance, allowing the board to monitor less. By contrast, advances in information processing lead to less disclosure since they allow more information to be extracted for any given set of data. From a social welfare perspective, we find that firms disclose too little, thus providing a rationale for regulation that enforces minimal disclosure standards.