The Dark Side of Information Dissemination

For decades, there has been an important debate over how much securities regulators should focus on protecting small investors. The regulators themselves have generally aimed to create a level playing field among investors, and historically, new technology has been an integral part of accomplishing this goal. Yet many posit that providing less sophisticated investors with better access to pertinent information can also impose significant costs on other market participants, regulators, and firms. Little, however, is known empirically about whether such costs exist or when they are greatest.

In a recent study, we investigate whether broadening the dissemination of corporate disclosures can lower investors’ incentives to engage in fundamental information acquisition. If doing so alters how much information investors acquire, it could affect how informative the stock price of a company is for its managers in making investment decisions.

When investors analyze securities, they produce private information. This information does not perfectly overlap with what a manager knows. For example, investors may have better information about the state of the economy, the competitive landscape, the production activities of suppliers, or consumer demand, which can be incrementally valuable for managers to make informed business decisions. Prior studies show that investors’ private information can be useful to managerial decision-making through a “market feedback” mechanism. The intuition behind the mechanism is that price is an approximate summary of the information and beliefs possessed by various market participants because investors as investors trade on this information, and their private information gets incorporated into the stock price. As such, a manager can examine her company’s stock price and glean some insight into what investors are thinking. Indeed, surveys of managers confirm that this feedback is one of the main reasons managers monitor their stock price.

To the extent that broadening corporate disclosure affects investors’ incentive to produce information, the amount of information impounded in a price but  unknown to the manager may also change, which, in turn, changes the amount of information a manager can learn from the market. We posit that increasing the dissemination of corporate disclosure induces investors to rely more on these corporate disclosures and less on acquiring costly private information thatis more likely to be unknown to the manager. Intuitively, producing private information is costly, so if investors can more easily access corporate disclosures, they will depend upon it more. This is especially true for small investors. When corporate disclosure is more widely disseminated, a stock price better reflects information from corporate disclosures. This reduces the trading benefits of producing private information that is potentially unknown to the manager. As a result, although the price may be more informative in general, it may become less informative to the manager.

To study this question, we exploit variations in the dissemination of corporate disclosure created by countries’ adoption of centralized electronic disclosure systems (CEDS). These systems centralize and digitize public financial disclosures, and the are among the most important and commonly used technologies for promoting equal access to nformation. A leading example of CEDS is the EDGAR system in the U.S. However, we explore the adoption of CEDS in 32 countries. Although these CEDS resemble the EDGAR system in that they centralize corporate disclosures, there is considerable variation in platform design, the timing of implementation, operators, and the type of information disseminated. An important advantage of our multiple-country setting is that it allows us to gauge what institutional features affect the magnitude of this decline in managerial learning from price and under what circumstances these costs are the greatest. This analysis may offer guidance to regulators conducting cost-benefit analyses for CEDS implementations or considering similar technological adoptions.

Our study makes three key findings. First, our main finding is that firms’ investment decisions are less reliant on their stock prices following the implementation of CEDS. Economically, the magnitudes of our estimated effects are meaningful, indicating a reduction of approximately 45 percent relative to pre-period levels. Second, in the cross-section, we find that the decline in managerial learning is concentrated among smaller countries, those with more opaque information environments, and those that create better platforms. Third, as peer firms’ information becomes more widely disseminated, managers increase their learning from peer disclosures. This effect partially offsets the costs we documented earlier.

There are two key takeaways from our study. First, leveling the playing field is not a panacea. Although improving smaller investors’ access to corporate disclosures promotes fairness, it can discourage information production by large investors and hurt corporate decision-making. Second, our cross-sectional analysis suggests that declines in price informativeness and managerial learning are greatest in countries that conceivably would benefit the most from CEDS. That is, larger benefits come with higher costs.

This post comes to us from Charles G. McClure, an assistant professor of accounting at the University of Chicago Booth School of Business; Shawn X. Shi, a PhD student at Stanford University Graduate School of Business; and Edward M. Watts, an assistant professor of accounting at the Yale School of Management. It is based on their recent article, “Disclosure Processing Costs and Market Feedback Around the World,” available here.