Optimal design and consequences of financial disclosure regulation: a real options approach

This paper examines the optimal design and consequences of financial disclosure regulation. Our model represents the regulation as creating a real option for an investor to delay investment until information is disclosed. We find conditions on investment opportunities that ensure that regulation raises or lowers investor profits. We also find that investment typically falls immediately after regulation, and that the long-term effects on investment and profits are distinct and depend on market characteristics. For parameters calibrated to the time around the Sarbanes-Oxley Act, we calculate the extent and period of disclosure to maximise individual investor profits. We calculate the optimal parameters for a two company market, show that company-specific regulation is profit maximising, and calculate the investor profit loss from having market-wide rather than company-specific regulations.