Window Dressing in a Regulated Transaction-Level Disclosure Regime

Abstract

This study examines whether managers window dress their year-end reports in a disclosure regime requiring the disclosure of transaction level investment data. Proponents of mandatory transaction-level disclosure argue that the opportunity to window dress is negated when all transactions can be observed, thus revealing a more accurate depiction of a firm’s during-period financial condition. We examine this conjecture by exploiting the U.S. based insurance industry, where all investment transactions are reported at the 9-digit CUSIP level. Although insurance companies may have incentives to increase investment risk to increase investment returns, they also have incentives to manage their year-end portfolio to circumvent regulatory scrutiny. Consistent with these incentives, our results suggest insurance companies increase risk during the year only to decrease risk significantly at year-end. This relation is magnified for firms with greater regulatory risk. This evidence suggests that the disclosure of transaction level data does not fully eliminate window dressing, even in highly regulated industries, likely due to processing costs and budgetary constraints of the regulator.