CeDEx 2016-19: The Enforcement of Mandatory Disclosure Rules (revised version of 2016-04)

Summary

Now published in Journal of Public Economics Volume 167, November 2018, Pages 21-32

In September 2004, the pharmaceutical company Merck voluntarily withdrew Vioxx–a pain medication for arthritis–from the world market, because a clinical trial indicated that it increased the risk of heart attacks and strokes when taken for at least 18 months. Later, however, it was discovered that the company had failed to warn of the drug’s dangers before the withdrawal. Following several scandals of so-called selective reporting of clinical trial results, the Food and Drug Administration Amendments Act (FDAAA) of September 2007 included the requirement of basic result reporting of clinical trials within one year after completion date. Mandatory disclosure rules have also been established in other areas in order to counter incentives for selective reporting. For instance, manufacturers of SUVs are required to report rollover risk in the US. This regulation followed an inquiry into a series of deadly accidents during which it was found that the tire manufacturer Bridgestone /Firestone and the auto company Ford had failed to inform the public about the risk of Ford Explorer SUVs rolling over after tires blew out without warning. The literature, however, has also recognized that mandatory disclosure rules must be complemented by enforcement, and that effective enforcement requires not only sizeable penalties but also appropriate resources to conduct inspections.

In this Nottingham School of Economics working paper, Matthias Dahm, Paula González and Nicolás Porteiro investigate the effects of such an enforcement. Enforcement of disclosure regulation is modelled as a supervising agency that invests resources in order to detect whether a firm held back information, and if so imposes a fine on the firm. The authors show that optimal monitoring is determined by a trade-off. Stricter enforcement reduces the incentives for selective reporting but crowds out information search. The model implies that (i) the probability of detection and the fine might be complements; (ii) the optimal monitoring policy does not necessarily eliminate selective reporting entirely; (iii) even when there is some selective reporting in equilibrium and more stringent monitoring is costless, increasing the probability of detection might not be beneficial; and (iv) when society values selectively reported information, the optimal fine might not be the largest possible fine.

CeDEx Discussion Paper 2016-19, The Enforcement of Mandatory Disclosure Rules by Matthias Dahm, Paula González and Nicolás Porteiro (revised version of 2016-04)

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Authors

Matthias Dahm, Paula González and Nicolás Porteiro

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