This paper examines how financial reporting regulations affect, and respond to, macroeconomic cycles by exploring a positive framework in which regulators subject to political pressures respond to cyclical demands by borrowers and lenders. We establish that, as economic conditions initially decline, political power shifts toward interest groups favoring less financial transparency. What follows is a counter-cyclical increase in economic activity, as more non-reporting loans are financed, possibly coincidental with more aggregate uncertainty. During a recession, reporting quality is increased, potentially causing a crisis-like adjustment of economic activity to the cycle. We also discuss implications for event studies, bank lobbying, mark-to-market and cost of capital.

We examine the impact of institutional ownership on financial reporting discretion, focusing on whether the impact varies with institutions' cost of acquiring monitoring information. Using geographic distance between the firm and the institutional investor as a proxy for the cost of acquiring monitoring information, we find that corporate managers are less likely to use financial reporting discretion in the presence of local monitoring institutions than distant monitoring institutions. We also find that the impact of monitoring institutions on financial reporting discretion varies with the costs and benefits of financial reporting discretion.