The Effects of Financial Reporting Regulation on Market Wide Resource Allocation
I investigate the impact of mandatory reporting and auditing of firms' financial statements on industry wide resource allocation. Using size based reporting and auditing requirements for limited liability firms in 26 European countries, I document reporting regulation, mandating a greater share of firms in an industry to disclose a full set of financial statements, fosters a competitive and dispersed type of resource allocation in product and capital markets, but does not unambiguously improve the efficiency of resource allocation. By contrast, I find auditing regulation, mandating a greater share of firms to obtain a financial statement audit, imposes a net fixed cost of operating on firms, deterring entry of smaller firms. I do not find any other effects of auditing regulation on industry wide resource allocation in my setting. My findings suggest reporting regulation substitutes a transactional type of resource allocation based on public information for a relational one based on private information. This substitution, however, fails to spur economic growth. With respect to firms' auditing, my findings suggest it lacks significant industry wide externalities compensating for firms' costs of mandatory auditing.