Disclosure by publicly listed companies provides critical information to the capital markets and benefits not only firms’ stakeholders but also the overall economy (e.g., Badertscher et al. 2013; Shroff et al. 2017; Barrios et al. 2021). However, the number of U.S. public companies has decreased steadily over the past 25 years. Compared with many other developed markets, the U.S. has few public firms, and this “listing gap” has drawn much attention from market participants, legislators, and regulators. In an influential study, Doidge, Karolyi, and Stulz (2017) conclude that a high number of public companies exiting the public equity market explains 46 percent of the listing gap.
One way that firms commonly exit the public market is by going private in a transaction or series of transactions that concentrate the ownership of the company and thus allow a firm to deregister its publicly traded securities. A unique aspect of going-private transactions in the U.S. is that they allow going-private firms to continue their business operations while substantially eliminating their disclosure obligations under the Securities Exchange Act of 1934. Going-private firms, upon the completion of the transactions, are no longer required to provide disclosures to the public, and virtually no private firms choose to do so voluntarily. This drastic reduction in available information is unique to the U.S., as going-private firms in other jurisdictions typically continue to provide information to the public if they meet certain size thresholds (e.g., revenue, assets, number of employees, etc.). For example, in the UK, the Companies Act requires going-private firms to file their financial statements, even if the firms have no publicly traded securities.
Decades of accounting research have shown that disclosure benefits extend beyond the disclosing firms. Disclosures made by other firms benefit peers within the same industry or subject to similar economic conditions through lower cost of capital and greater investment efficiency. This information spillover creates social value. Prior to the going-private transactions, peer firms’ managers could access the going-private firms’ disclosures to identify the going-private firms’ product market strategies and growth opportunities. Similarly, peer firms’ shareholders could use such disclosures to benchmark the performance of their portfolio firms and evaluate the competitive environment of the industry. Consequently, going-private firms’ disclosures help reduce information uncertainty surrounding peer firms.
We argue the information loss associated with going-private activity has potential consequences for industry peers because the spillover effect weakens significantly. While extensive research has examined the wealth effects of going-private transactions on shareholders, the informational implications of going-private transactions to peer firms are largely unexplored. In our study, we examine the effect of going-private activity on peer firms’ disclosures using 482 going-private transactions completed between 2006 and 2015.
Effect of Going-Private Activity on Peer Firms’ Information Environments
As our first step, we evaluate the effect of going private on peer firms’ information environments by examining the accuracy of financial analysts’ earnings forecasts. Financial analysts are sophisticated information intermediaries who usually incorporate industry rivals’ information into their forecasts. Using earnings forecasts issued during periods when there are no going-private events as the benchmark, we find forecasts of peer firms’ earnings issued by analysts when there are going-private events are significantly less accurate. This evidence suggests the information loss following going-private activity leaves peer firms with deteriorated information environments and is consistent with less information transfer after going-private transactions.
Peer Firms’ Disclosure Response
We then examine peer firms’ disclosure decisions in response to going-private activity. The peer firms no longer get the benefit of information from the now-private firms. To regain that benefit, we expect peer firms to provide higher-quality disclosure about themselves. We measure two dimensions of disclosure quality in peer firms’ annual reports: the level of quantitative detail in firms’ financial statements and footnotes and the amount of new qualitative information in firms’ narrative Management Discussion & Analysis section. We find peer firms increase both quantitative and qualitative disclosure quality following going-private activity. Specifically, peer firms provide more detail in their financial statements and more updated information in their MD&A sections when there is a higher level of going-private activity within their industry. In additional tests, we find that more detail about special items and property, plant, and equipment accounts for most of the increase in disclosure quality after going-private activity. This result is consistent with prior literature that finds special items and capital investments provide valuable information to investors.
Furthermore, we expect peer firms’ disclosure responses to vary cross-sectionally along several dimensions. Going-private activity likely represents a greater information loss for firms that benefit more from information spillover. Consistent with this prediction, we find firms relying more on intra-industry information transfer and firms with relatively weaker information environments improve their disclosure quality more to restore the information lost after going-private activity. In addition, competitive pressure might prompt heterogeneous disclosure responses among peer firms. Following the completion of the going-private transactions, peer firms continue to compete against the going-private firms in their respective product markets while no longer having access to the going-private firms’ financial reports. Meanwhile, the going-private firms maintain their access to their public peers’ disclosures and strategic information. As the information transfer goes one-way, certain peer firms could become more sensitive to the proprietary costs associated with disclosing more precise disclosure and thus reluctant to provide this information to the public. As predicted, we find the increase in disclosure quality is mainly concentrated in firms facing less intense competition.
Disclosure Response to Private M&A Deals
We posit that weakened information spillover drives peer firms to increase disclosure quality. To corroborate this argument, we investigate peer firms’ disclosure responses to M&A deals in which both the acquirer and target are private companies. Private companies provide no disclosure or information transfer to their public peers; thus, private M&A deals arguably have no effect on the information spillover before or after the transactions. Indeed, we find peer firms’ disclosure decisions are not affected by the private M&A deals within their industries, supporting the conclusion that weakened information spillover prompts peer firms to provide higher-quality disclosures to the capital markets after going-private activity.
We shed light on an important peer effect of going-private transactions that has been under-examined in prior research. Our evidence suggests that the lost information associated with going-private activity imposes a negative externality on peers that remain public and prompts peers to incur costs to regain the lost informational benefits. This finding is especially timely and relevant to regulators as public-to-private transactions are on the rise and are likely to continue to increase due to the growth of the private equity industry. Further, the SEC is currently in the early stages of a plan to require large private firms to routinely disclose financial and operational information (Kiernan 2022). While our study cannot speak to all the consequences of disclosure regulation, it can provide information on the substantial role of a firm’s information to the wider capital markets and the social value and externalities associated with that information.
Badertscher, B., N. Shroff, and H. White. 2013. Externalities of public firm presence: Evidence from private firms’ investment decisions. Journal of Financial and Economics 109 (3): 682-706.
Barrios, J. M., J. H. Choi, Y. V. Hochberg, J. Kim, and M Liu. 2021. Informing entrepreneurs: Public corporate disclosure and new business formation. Working paper, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3640736 accessed March 8, 2022.
Doidge, C., G. A. Karolyi, and R. M. Stulz. 2017. The U.S. listing gap. Journal of Financial Economics 123(3): 464-487.
Kiernan, P. 2022. SEC pushes for more transparency from private companies. Wall Street Journal, January 10, https://www.wsj.com/articles/sec-pushes-for-more-transparency-from-private-companies-11641752489 accessed March 8, 2022.
Shroff, N., R. Verdi, and B. Yost. 2017. When does the peer information environment matter? Journal of Accounting and Economics 64: 183-214.
This post comes to us from Lisa A. Hinson and Jeffery Piao at the University of Florida. It is based on their recent article, “Disclosure Spillover from Going-Private Activity,” available here.