We examine the evolution of accounting regulation by linking disclosure policies and investments in a dynamic voting model. The disclosure policies are the outcome of voting by entrepreneurs, whose preferences are influenced by their investments. The investments are in turn endogenously determined by current and future disclosure policies. Absent external influences, accounting regimes are stable. A disclosure regime of high (low) quality and a strong (weak) economy coexist and reinforce each other. However, regulatory interventions can result in regime changes by changing the entrepreneurs’ expectations, even without direct enforcement. Unexpected shocks could also result in regime changes by impacting economic conditions and hence voter composition. Our analysis provides a framework to study the interaction between accounting regulation and firms’ economic decisions.

This paper studies the asset pricing implications of industrial pollution. A long‐short portfolio constructed from firms with high versus low toxic emission intensity within an industry generates an average annual return of 4.42%, which remains significant after controlling for risk factors. This pollution premium cannot be explained by existing systematic risks, investor preferences, market sentiment, political connections, or corporate governance. We propose and model a new systematic risk related to environmental policy uncertainty. We use the growth in environmental litigation penalties to measure regime change risk and find that it helps price the cross section of emission portfolios' returns.