CORPORATIONS ON THE COUCH: IS THERAPEUTIC DISCLOSURE A KIND OF MADNESS?

• Author: Tingle, Bryce C.

Over the past decade, regulators and various third parties have advanced a relatively new type of corporate disclosure. Only peripherally related to the financial performance of the affected corporations, and usually involving risks that fall well outside the relatively short period of time in which they can be accurately assessed and reflected in security prices, the new disclosure is designed to induce better corporate behaviour. (1) "Therapeutic" disclosure is not completely new--the biggest experiment in therapeutic disclosure began in relation to executive pay in the early 1990s--but its scale is new. We now have disclosure practices either mandated or urged that have as their entirely laudable intentions: reducing inequality, (2) improving diversity, (3) preventing conflicts in the developing world, (4) reducing corruption, (5) producing more ethical behaviour (at least as defined in corporate codes of ethics), (6) combatting the use of slave labour, (7) and, most notably, encouraging better social and environmental practices. (8)

The rhetoric around these various disclosure initiatives is suffused with assertions that they are, in fact, advancing shareholder value. Professors Lund and Pollman use these representations to support their argument that the shareholder interest is so dominant in what they term "the corporate governance machine" that even socially important initiatives that have very little to do with advancing the financial interests of shareholders must pretend to do so in order to be acceptable in our current governance culture. (9) It is outside the scope of this paper whether shareholders, in fact, make use of this disclosure in arriving at investment decisions, and whether those investment decisions improve outcomes for investors, or direct capital in ways that support socially superior business models. These outcomes, however, seem unlikely. (10) Instead, this paper is concerned with the claims--mixed in with the appeals to shareholder value--that these disclosure initiatives will themselves cause improvements in corporate behaviour. In a memorable formulation of this sort of claim, professor Louis Loss argued that "[p]eople who are forced to undress in public will presumably pay some attention to their figures." (11) But is this true of that notably shameless and distracted creature, the public corporation?

This paper begins with a discussion of the logic behind therapeutic disclosure and its growing influence on corporate disclosure practices. Part II of the paper discusses the reasons why, in theory, therapeutic disclosure is unlikely to alter corporate behaviour. Part III will turn to the empirical evidence on the efficacy of the various therapeutic disclosure regimes we have actually tried in order to: reduce executive pay, increase board diversity, improve ethical behavior, and reduce foreign corruption. These initiatives have not had the effects on firm behaviour that reformers hoped, and because of the public nature of corporate disclosure, the new rules have often produced perverse results.

1. THE LOGIC OF THERAPEUTIC DISCLOSURE

   Disclosure can be said to have a therapeutic function "when its ultimate goal is to induce desired corporate behavior." (12) The channel through which this kind of disclosure is supposed to operate varies according to the author. Some emphasize that therapeutic disclosure forces managers and directors to focus on aspects of their own conduct or the "disagreeable realities" of their business operations. (13) By raising the consciousness of insiders about various types of bad behaviour, the disclosure exercise will motivate them to improve. (14) Professor Cass Sunstein, on the other hand, emphasizes the "expressive" function of law: its capacity to communicate social norms and, in doing so, change behaviour. (15) Other scholars argue that disclosure can produce behavioural change through publicly shaming companies that are forced to disclose socially disfavoured activity. (16)

   It is useful to note the types of disclosure that do not qualify as "therapeutic" as we are using the term in this paper. Disclosure obligations which are not primarily intended to change corporate behaviour are not "therapeutic". This includes, for example, most of the disclosure obligations historically imposed on public companies. The financial disclosure that forms the core of modern securities reporting is intended to provide a window on what has occurred in the corporation's business, not to change it. (17) "The main purpose of corporate disclosure is to increase transparency (or decrease informational asymmetries) to foster more efficient public markets." (18)

   Disclosure also does not operate as "therapeutic" when corporate behaviour changes because of the intervention of an outside party. (19) If, for example, corporate reporting provides evidence that anti-corruption laws have been violated, prompting action by regulators to discipline the corporation, this is not "therapeutic" disclosure. While the disclosure has led to a change in corporate behaviour, it hasn't arisen from the disclosure itself affecting corporate managers, it has arisen from the actions of an outside party.

   Climate change disclosure provides an illustration of the different objectives that may theoretically be advanced by corporate reporting. One rationale for requiring this sort of disclosure is that climate change imposes idiosyncratic risks on individual companies that are difficult for outsiders, such as shareholders, to anticipate without more information from insiders. (20) This is the traditional reason for disclosure requirements. Another rationale for climate change disclosure is that it will provide various outside groups with the information they need to begin public pressure campaigns (such as consumer boycotts or regulatory interventions) to change corporate behaviour. (21) The third possible rationale is that the disclosure process, itself, will--as a result of consciousness raising, norm communication, or shame--result in managers changing their behaviour. (22) Only this third rationale for climate change disclosure counts as "therapeutic".

   A significant part of therapeutic disclosure's appeal is that it is a form of substantive regulation without obviously appearing to be such. Regulators are supposed to be neutral as to the law-abiding business operations of public firms; Canada's various Securities Acts, for example, generally do not give securities commissions in this country the power to do more than protect investors or ensure fair and efficient capital markets. (23) Securities commissions cannot pick and choose among companies seeking to go public and permit only those whose industry or social practices they favour. (24) Passing therapeutic disclosure requirements allows regulators to remain ostensibly neutral while disproportionately affecting some types of companies, hopefully in ways that will produce a favoured social outcome. (25)

   Indeed, because disclosure lies at the heart of securities regulation (in large part because it leaves substantive decisions to the market), therapeutic disclosure looks like something securities commissions should be permitted to do. (26) As well, it is easy to claim most social or environmental issues result in risk to a company over a suitably long time horizon, so therapeutic disclosure initiatives can often be cloaked in terms that suggest the disclosure is largely intended to assist investors in pricing future corporate cash flows. This rhetoric is deployed even in cases where there is little evidence firm-specific (as opposed to economy-wide) risks exist, little chance corporate insiders will be better able to predict the future than any informed market participant, where the risks will be incurred well outside any reasonable time frame for either accurate predictions or appropriate valuation, in a time frame where other risks--regulatory, competitive, or technological--are likely to swamp the impact of the specific risks being disclosed, or where the risks are highly speculative. (27) One likely reason for the increasing appetite for therapeutic disclosure is a political climate in which democratic change is hard to achieve, making action undertaken by regulatory fiat an appealing substitute. (28)

   The move to therapeutic disclosure has another cause, and that is the way it fits within the foundational assumptions of the modern corporate governance project. Whereas corporate law historically and doctrinally concerns itself with supporting ex ante corporate governance bargains, modern public market reforms are preoccupied with securing ex post welfare outcomes. (29) If we look at the central debate today in corporate governance--shareholder versus stakeholder conceptions of corporate purpose--we can see that they actually share this distinctively modern assumption. Therapeutic disclosure's substantive nature would have seemed completely out of place forty years ago, but it now fits within this relatively modern perspective.

   For these reasons, calls for ever more therapeutic disclosure are at a peak. (30) In Canada, Ontario's Capital Markets Modernization Task Force recently proposed that companies start providing generalized social and environmental disclosure. (31) In response, a letter prepared by a Canadian corporate law firm and signed by a dozen prominent Canadian companies pointed out that Canadian securities laws already require issuers to disclose environmental and social information if it is "material". (32) Indeed, multiple CSA Staff Notices have been published on this topic in recent years. (33) "Materiality" in Canada's Securities Acts is tied to the value and the price of an issuer's securities. (34) Non-material information is, by definition, information that does not impact investors' calculations of risk and future cash flows. The most likely purpose, therefore, for requiring additional disclosure that is, by...