Scholar highlights some of the successes of mandatory disclosure policies.
Mandated disclosure requires sellers to disclose information about the products and services they offer. This common regulatory tool is designed to protect consumers by allowing them to make informed decisions. Yet, according to More Than You Wanted To Know: The Failure of Mandated Disclosure by Omri Ben-Shahar and Carl E. Schneider, mandated disclosure has failed to reach its regulatory aims. Ben-Shahar and Schneider argue that mandatory disclosure cannot be fixed and should no longer be used by policy makers.
For a policy as popular as mandated disclosure, documenting pitfalls is valuable. Whether the errors warrant a universal dismissal of mandatory disclosure is another question. A variety of studies show a wide range of results, both theoretically and empirically, on the effectiveness of the disclosure regime. Before we rush to abandon mandated disclosure, it is worthwhile to think about it in a more balanced view.
Ben-Shahar and Schneider offer several arguments to support their stark conclusion. They assert that many information disclosures are insufficient to make consumers well informed, because they cover complex and unfamiliar subjects that are difficult to sum up in a clear, simple format. Because of this, they claim, many consumers do not read the disclosures. Most consumers prefer simple, readable information when they make a purchase decision.
However, ignoring fine print in a credit card application does not generalize to all cases of mandatory disclosure. I read the nutrition label of some grocery products; I compare mileage information and rollover risk when I shop for an SUV; and the calorie counts posted on a restaurant menu do sway my choice of dishes. The fact that people frequently skip over fine print speaks more to the importance of information format than about a general failure of mandatory disclosure.
Behind Ben-Shahar and Schneider’s thesis is an implicit assumption that mandated disclosure only works through consumers’ effective use of the disclosed information. This is not necessarily true. When disclosure is mandatory, sellers can no longer claim that they do not know a problem exists. As evidenced in the case of SUV rollover ratings, compliance with the disclosure mandate led car manufacturers to quantify the rollover risk, improve its measurement over time, and adopt industry standards to solve the problem.
The fear of looking bad in front of the public may also motivate changes, even if the disclosed information does not trigger massive consumer response. After Medicare posted ratings of dialysis facilities, those facilities that received negative quality ratings subsequently experienced a reduction in patient mortality rates, although the ratings had no impact on overall patient volumes. Similarly, the 1986 mandate of toxic pollution reporting motivated some large companies to commit to reducing pollution by as much as 90 percent, even before the first company reports. In another context, a mandate for water utilities to disclose water contaminant levels motivated large utilities to reduce total violations by 30 to 44 percent and more severe health violations by 40 to 57 percent, despite the fact that consumers themselves can do relatively little to switch water sources even after reading contaminant reports. These examples suggest that mandated disclosure can affect behavior through a channel other than consumer response.
Another argument advanced by Ben-Shahar and Schneider is that simple disclosures are easily distorted, encouraging firms to game the system. It is not surprising that firms have found ways to distort information in mandated disclosure. However, a firm bothers to game the system precisely because it believes the disclosed information will have some bite on its business. To the extent that mandatory disclosure motivates sellers to pay attention to the disclosed information, it is a success. To make it more successful, we need to study the gaming behavior and identify the related loopholes, rather than take out a firm’s incentive to improve.
Using restaurant hygiene grade cards as an example, Ben-Shahar and Schneider cite evidence of information distortion, namely the high concentration of San Diego restaurants in grade “A.” Data are never perfect. If we have to discard a policy tool because it is based on imperfect data, there would not be many policies left on the table. A more constructive approach would be to dive into the data and come up with a better method to measure what we really care about.
Again, the case of SUV rollover ratings is a good example. Congress mandated manufacturers to disclose each model’s rollover risks, but it also required the ratings to become more accurate over time. Like restaurant hygiene grades, the distribution of rollover ratings has shrunk dramatically after mandatory disclosure, but the shrinkage could reflect actual improvement rather than information distortion.
Furthermore, Ben-Shahar and Schneider ague that mandatory disclosure requires coordinated actions and crowds out alternative policies and information channels, leading to large, hidden costs. Every regulation carries the opportunity cost of crowding out other policies. For mandatory disclosure, what are the alternatives?
Voluntary disclosure might be the closest alternative. Policymakers may specify how the disclosure should look while leaving to firms the decision of whether to disclose in the first place. Consider a 2011 Maricopa County, Arizona, policy allowing each restaurant to choose whether to post its letter grade online and offline. Regardless of the disclosure choice, detailed hygiene inspection reports have been available online since 2007. Only 57.6 percent of Maricopa inspections led to online letter grade posting after the policy and this percentage declined slightly over time. Moreover, 48 percent of the non-disclosing restaurants had received an A grade. Also, the total number of violations per inspection decreased only slightly after the voluntary disclosure policy, in contrast to the massive distributional shift in Los Angeles County after most cities adopted mandatory disclosure there. It is difficult to compare two policies in different locations and different times, but my guess is that Maricopa residents are more confused than Los Angeles residents, if they ever bother to look at the disclosed information.
Another alternative to mandated disclosure would be to adopt minimum quality standards, where products and services below a certain threshold are simply excluded from the market. It is not obvious that the data driving a minimum quality standard will be better than mandatory disclosure. Mandatory disclosure at least makes the data problem transparent and salient to many people beyond the policymaker, and knowing where the problem is often the first step towards solving it. Furthermore, minimum quality standards have their own downsides as well. For example, they may discourage entry and preclude consumers from low-quality choices.
As a researcher who has done some work on mandated disclosure, I appreciate a spotlight on its pitfalls. These pitfalls are good reasons to study and improve mandatory disclosure, but it is premature to conclude that policy makers should forget about mandatory disclosure once and for all. A more relevant question is what factors determine the effectiveness of mandatory disclosure in achieving its policy goals. As the research grows, we will better understand mandated disclosure and its tradeoffs when stacked up against alternative policies.
This essay is part five of a seven-part series in The Regulatory Review entitled, Is Mandatory Disclosure Helping Consumers?