Emerging Issues: Impact of Disclosure Reduction on Capital Markets

This report critically examines the impact of reduced disclosure regulations on capital market efficiency. It begins by defining market efficiency and the efficient market hypothesis, exploring the weak, semi-strong, and strong forms. The report then analyzes the amendments to disclosure requirements, highlighting the simplification efforts by regulatory bodies like the SEC and FASB. It also delves into the signaling theory, which explains the information gap between firm management and shareholders. The report further discusses the initiatives by regulatory bodies to mitigate the impact of reduced regulations, evaluating whether these initiatives contradict the objectives of the SEC and FASB. Finally, it concludes by stating a position on whether the reduction in disclosure requirements may harm investors, providing a comprehensive analysis of the issue and its implications for the capital market.

Running Head: IMPACT OF REDUCTION IN DISCLOSURE REGULATIONS
IMPACT OF REDUCTION IN DISCLOSURE REGULATIONS
NAME OF THE STUDENT
NAME OF THE UNIVERSITY
AUTHOR NOTE

1Impact of Reduction In Disclosure Regulations
Table of Contents
Introduction......................................................................................................................................2
Discussion........................................................................................................................................2
Efficient Market Hypothesis........................................................................................................3
Signalling Theory........................................................................................................................5
Initiatives by the Regulatory bodies................................................................................................6
Impact of reduction in disclosure regulations on capital efficiency................................................8
Contradiction with the objective of SEC and FASB.......................................................................9
Conclusion.....................................................................................................................................11
References......................................................................................................................................13

2Impact of Reduction In Disclosure Regulations
Introduction
Market efficiency is defined by the level of disclosure of the market prices that include
all kinds of relevant information within. It has to be noted that efficiency of market is determined
by the fact that all the required information will be included in the market prices and therefore,
there will be no way to beat the market. Since there will not be any undervalued or overvalued
securities. Eugene Fama has discovered the term efficient market during the year 1970s and as
per his efficient market hypothesis he has stated that it is difficult for the investors to perform
above the standard and that deviation in the market is not expected in the efficient market, since
any such thing will be arbitraged. As the market becomes more efficient it reduces the
opportunities of arbitrage and extra market returns.
The study of the efficient capital market examines the fact that how quickly and
efficiently the available information in converted into the security prices. The market is
categorized under three categories on the basis of the available information. The three categories
are weak, semi-strong and strong, where in the weak market investors can’t earn profits from
trading rules and the stock prices here are not predictable. In the semi-strong efficiency, security
prices fully reflect all kinds of public information. Lastly, under the strong setup all kinds of
information including the company’s secret are inclusive in the market prices (Efficiency in
Capital Markets 2020).

3Impact of Reduction In Disclosure Regulations
Discussion
There has been an adoption of certain amendments to certain of the disclosure
requirements which have become quite redundant, overlapping, and duplicative, outdated in the
light of other disclosure requirements by the commission, US generally accepted accounting
principles and also the changes in the information environment (Virtusinterpress.org. 2020).
There are certain information in the commission disclosure requirements, which generally
overlap with the information that is important to the US GAAP to the Financial Accounting
Standards Boards (FASB) for the incorporation into the GAAP. The amendments are basically to
simplify the compliance and facilitating the disclosure of information to the investors without
altering any aspect of the total mix of information that is provided to the investors. Along with
that there is also a hope that these amendments will further improve the investor’s ability to
make the decisions related to the investment in a more efficient manner in order to reduce the
compliance cost which will further lead to the formation of the capital.
Efficient Market Hypothesis
The investment theory which is derived from the concept of Eugene Fama’s research
work from his book “Efficient Capital Market: A review of theory and empirical work”. He has
forefronted the idea where it was difficult or impossible for the investors to beat the market or to
outperform the investment. In his theory, Fama has highlighted the fact that even if the investor
gets lucky to earn huge profits for the short term, however, in the long run the investor won’t be
able to expect the higher yield above the market average (Corpgov.law.harvard.edu. 2020).
However, it has been noted that Fama’s theory has the same implications as that of the
random walk theory which is based on the various assumptions relate to the security markets. All

4Impact of Reduction In Disclosure Regulations
these assumptions has one clear idea that is the belief that the information pertaining to the stock
prices are freely available and this is critical to the validity of the efficient market hypothesis.
Since there are huge numbers of buyers and sellers in the market, which enables the price to
move efficiently and therefore, there are stocks that are traded at the current fair market value.
Due to the trading that happens in the fair market value there are no chance for the
investors to buy undervalue stocks or to sell overvalued stocks for extra profits. Neither will the
stock analysis by the expert nor will the carefully implemented market timings strategy will be
able to outperform the market, hence there are no way for arbitration. Therefore, in this situation
the only way to get superior returns is to take much risks.
There are three variations in the hypothesis which are the weak, semi-strong and strong
forms which defines different levels of market efficiency based on the available information. In
the weak form it is assumed that the prices of the securities will include all the information that
are public, however it might not include those information which are not made public yet. It
implies that consistent excess returns are not expected out of these securities. Semi-strong
believe in the fact that all the publicly available information are listed in the prices of the
securities. It does include the weak form assumptions with the belief that it will quickly adapt to
the new public information that has been made available. Therefore, it does have a predictive
value attached. Strong form is where all the related information are listed in the prices of the
securities. Along with that they also have the company’s secret information available within the
prices. It gives the investors a strong prediction benefits which enables them to outperform
market and reap higher returns from investment. (Corpgov.law.harvard.edu, 2020)
It is being said that the FASB and the SEC aim to target for the financial disclosures for
the sophisticated investor rather than targeting the naïve investor. By sophisticated investor it is

5Impact of Reduction In Disclosure Regulations
being indicated towards the stock analyst, who are more likely to affect the prices. It has to be
noted that the naïve investor does not literally understand the annual report and therefore, he and
she feels they are encountering the fair prices. Even though there are information included in the
prices, the naïve investors actually doesn’t understand anything fully, it is the traders who can
misuse the information which are not reflected in the price, since they know more about it.
People therefore, rely on the EMH. However, it is not assured that market can unambiguously
predict the future events. The stock prices do react, whenever there are new information
available. However, the EMH does not give an implication that the market are intuitive and that
only the past information can be proved to be helpful in the prediction of the future abnormal
returns.
Signalling Theory
Information gap or asymmetries between the firm management and the shareholders
leads to the development of the signaling theory. It is done in a way that if the management
thinks that the firms are overvalued then they will issue the equity first and the debt lastly. In the
same way, when they will find their firms to be undervalue they will issue the debt first and then
the equity. The signaling theory has been introduced by Ross who posted that if the managers
has inside information and accordingly if they tailor-made their capital structure. Their choice of
capital structure will give information to the market. Debts contracts are the commitment by the
managers to make future interests payments. Leverage shows a positive sign that if there are
increased debt then the managers are confident about their future earnings. However, failure to
repay the debt will lead to the bankruptcy.
The major implications of the signalling theory will be that the managers will try to fix
the timings related to their equity issues that are based on their interpretation of the market

6Impact of Reduction In Disclosure Regulations
assessment of their shares. For example, Baker and Wurgler has a strong relationship between
the financing decisions and the historical market values of the equity. This shows the results of
the managers past attempts to have an implemented market timing management related to their
capital structure of a firm. However there are no evidence related to the Europeans managers that
they signal their private information in order to influence their capital structure.
Signalling theory assumes the fact the if one manager of a firm has disclosed some data
previously, and another manager from the same industry discloses that related data and the
manager of the previous firm has failed to disclose the data, will be treated as the signal by the
market that the unpublished data are adverse. This lead to the creation of powerful incentive to
disclose. However, this theories does not account the incidence of the securities fraud, which is
why it seemed to be increasing day by day. These theories does not able to explain why these
small firms who are not subject to those SEC mandatory corporate disclosure. These firms seem
to be responsible for the majority of fraud cases that has been brought to light by the
commission. Neither do this theory explain as to why the firms make use of the practices such as
the income smoothing in order to obscure their bad economic news (MEASURING
SECURITIES 2020).
Initiatives by the Regulatory bodies
There are various effects of the disclosure on the efficiency of real investment decisions.
In order to evaluate the effect of the disclosure is to know the implications of such disclosure to
the welfare of the traders. The argument that are in favor of the disclosure states that it improves
the market quality which in turn have a positive effects on the investors in the financial markets.

7Impact of Reduction In Disclosure Regulations
However, there are several laws that has shown the negative impacts of the disclosure on the
welfare of the investors. (Virtusinterpress.org, 2020)
The SEC has adopted amendments to the disclosure requirements that “have become
redundant, duplicative, overlapping, outdated or superseded in the light of other commission
disclosure, U.S GAAP or the changes in the information environment”. With the implication of
this amendment, the SEC eliminated the requirement that companies report the ratio of earnings
related to the fixed charges of exhibit. The amortization of capitalized interest which is a non-
operational expense which is included in the operational earnings. This is the line item which has
been a part of the exhibit. For example, if one remove this expense while calculating the after tax
operating profit (NOPAT), since it is a part of the finances of the company’s operations and not
the operations themselves. This has been done to have a more accurate view of the normal
recurring profits (Disclosure Simplification 2020).
In most cases, interest costs gets expensed and reported as non-operating. Therefore, in
cases where debt is used for financing long-term asset, accrued interest can be capitalized on the
balance sheet and can be expensed as the amortization over the period of time. Due to this,
GAAP allows the cost of interest to be categorized as the operating expense in spite of it being
the finance cost (Information Disclosure 2020).
There are things which are not available easily and that are used in the ratio of earnings to
fixed charges such as the portion of the lease expense that are represented by the interest and the
amortization of the capitalized interest. In spite of the fact that these details are not readily
available, the SEC has still decided to remove the requirements of disclosure of this information.

8Impact of Reduction In Disclosure Regulations
Effectively applied to all the public entities, ASU 2017-12 has amended the hedge
accounting and its presentation requirements. The main goals for this amendment was to provide
a complete picture to the users of the information related to the hedge accounting and its effect
on the income statement and the balance sheet and the second motive was to ease the operational
burden of the application of hedge accounting by distributing more time in the preparation of the
hedge documentation. The invention of the new amendment will lead to the significant reduction
in the disclosure of the hedge ineffectiveness. With this amendment, there will be no need for the
firm to separately measure and report their hedge ineffectiveness. Initially which used to be
separately set out as ineffectiveness will now have to be buried in the other comprehensive
income until the entire hedge is recognized from the other comprehensive income and into the
income statement. When the hedge is categorized from the other comprehensive income to the
net earnings. It will be reflected in the same line item as the hedged items with no differences
reflected in the effective and the ineffective portion. This lack of setting off lead to the reduction
of transparency and the analytical value in the financial statements. Therefore, this FASB
amendment as compared to the SEC change in the above section, it highlight and put more
priority to the reduction of the reporting entities burden rather than providing valuable
disclosures to the investors (Accounting Standards 2018).
Impact of reduction in disclosure regulations on capital
efficiency
Both the changes that are made by the SEC and the FASB are intended for reducing the
cost of filing for the reporting entities, FASB parlance for the companies, reduction and
elimination of certain redundant and unimportant disclosures. However, it has to be noted that

9Impact of Reduction In Disclosure Regulations
the changes has led to the elimination of two important disclosures one being the amortization of
capitalized interest and hedge ineffectiveness. These two are the main factors that the investors
need to assess the earnings and the cash flow in an accurate manner. Recent research has also
examines the international differences in the disclosure and the securities regulation and also
their impact on the market that will include the cost of capitals for the firms. The firms like La
porta, Shleifer has provided the evidence that the stricter and the better enforced regulation
related to the securities has an association with the development of the financial market for
example the size of the equity market of the country and the IPO activity (Regulation of Cash
2019).
It has been noted and has been proved after the examination of the international
differences of the firms cost of equity capital in the forty countries in the world and their
association with the legal institutions and the security regulations of their countries. The result,
however, support the fact that firms from the countries that have more extensive disclosure
requirements, and those who have stronger security regulations and stricter mechanism to
monitor it, have significantly lower cost of capital. It has been note that the cost of capital seems
to be much smaller for the capital markets which are more globally integrated. However, on the
other hand the cost of capital is higher for those with segmented capital markets (Capital-Market
Effects 2020).
The following conclusion has an important significance in the Canadian market which is
subject to higher integration with the US capital markets around the globe. However, it has to be
noted that the study does not provide any strong evidence to prove the relation between the perks
of strict disclosure regulation overweighting the costs and therefore, the cost of the regulation
has to be considered thoroughly.

10Impact of Reduction In Disclosure Regulations
Contradiction with the objective of SEC and FASB
Capital market is the place that proves to be as the channel to move the fund from the
investors or savers to the firms, who use them to finance their projects. Thus efficient capital
markets allows thee firm to easily raise the capital since the prices which is determined by the
market are those over which all the potential existing security holders are willing to exchange
their claims over the firm’s future cash flows. Another reason is that there are many investors
who does not have too much of a time to spent them on the research or extensive analysis.
Therefore, they will to invest their savings in the market where they feel that the prices
mentioned there are accurate. Therefore, their first choice is always efficient markets and it also
enables the function of the capital market to increase manifold of transformation from savings to
the productive projects (Capital Market Theory 2020).
The main motive for the amendments as specified by the SEC is to update and simplify
the commission’s current disclosure requirement which will:-
 Eliminate certain disclosure requirement which seemed to be redundant and repetitive in
the U.S GAAP, IFRS and other commission disclosure requirements
 Deletion or integration of provisions that address disclosure topics that are already
covered elsewhere in the rules and regulations to avoid the overlapping
 Revision of certain disclosure that are outdated
 Revision of certain superseded commission disclosure requirements to update it with the
latest updated U.S GAAP requirements (SEC Adopts Amendments 2019).
The main motive of the FASB is that special accounting that are related to the items that are
designated as being hedged should only be provided for the qualifying items. One aspect of the

11Impact of Reduction In Disclosure Regulations
qualifying item being the assessment of the expectation for the effective offsetting changes in the
fair values or the flow of cash during the term of the hedge for the risk that are being hedged.
However, it has been noted that this FASB amendment as compared to the SEC change in
the above section, it highlight and put more priority to the reduction of the reporting entities
burden rather than providing valuable disclosures to the investors. Apart from that there is also a
fact that the SEC wanted to remove those rules that are already getting covered in some or the
other part of the financial statements. In order to avoid the overlapping of such rules this
amendment has been said to be applied. However, with the implication of such amendments
there has been certain reduction in the disclosure of certain elements which are crucial for the
investors to accurately measure the implication before taking the investment plan.
Conclusion
It has to be concluded that this is not the only instance of the SEC which is allowing the
disclosures of the valuables to the investors. It has been observed that on June 2018, the SEC has
proposed the idea of increasing the market capital limit over which the firm has to disclose the
auditor’s opinion on their internal controls for the recording of their financial reporting. It has to
be noted that the overwhelming financial disclosures are not an exaggerating part for the
investors. However, it is nowhere written, that the solution to this problem is to reduce the
disclosures, where due to the growing complexity of the businesses, there are ever growing
requirement of the more minute disclosures. The main concern that will help the investors will be
to leverage more technology to analyze financial fillings and disclosures in more efficient
manner.

12Impact of Reduction In Disclosure Regulations
Regulators are seemed to be more in pressure for the fulfillment of their obligations with
the limited resources and therefore, this might lead to the emergence of natural tendency of
reducing certain disclosures which they are needed to review. With the help of technological
support, there might not be any requirement for the reduction of the steps of disclosure in the
systems.
Therefore, the conclusion here lies with the opinion that reduction in the disclosures of
the important elements has led to the reduction in the transparency which will allow the investors
to accurately measure the benefits related to the investment plan. It further enables the greater
market liquidity and the lower cost of capital. Furthermore, it has been noted that large
shareholders and the corporates leaders may be able to extract private benefits with the
controlling of the firms. Therefore this will lead to the reluctance on the part of those leaders and
the shareholders to be open for the corporate disclosures, which may become hindrance for them
to take their private benefits. Therefore, from every point of view it is pretty much clear that with
such complexities in the business world, there are more requirement of the technology to parsley
note down the disclosure rather than reduction of the disclosure to avoid extra work.

13Impact of Reduction In Disclosure Regulations
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15Impact of Reduction In Disclosure Regulations
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