NCPA - National Center for Policy Analysis


June 10, 2005

In 2000, the Security and Exchange Commission issued Regulation Fair Disclosure (FD) to stop firms from selectively disclosing information to only a few analysts and institutional investors before disclosing it publicly. While the regulation may have been economically sound, it has been a tremendous burden on small firms, according to an article from the National Bureau of Economic Research.

Firms can disclose information in two major ways:

  • They can produce formal, public reports (either in-house or contracted out) or through more informal, one-on-one meetings.
  • Regulation FD tried to curb the one-on-one meetings to prevent abuse of inside information, however, formal publication is much more costly than informal meetings and this favors large firms over small firms.

The researchers used quarterly data from NYSE and NASDAQ firms from 1997 to 2002. They analyzed the effect of Regulation FD on various market variables, including analyst following, forecast errors, and volatility at earnings announcements and found:

  • On average, small firms lost 17 percent of their analyst following, while large firms increased their following by 7 percent.
  • Smaller firms experienced higher forecast errors and more volatile market responses to their earning announcements, while large companies did not.

This suggests that large firms were able to switch from one-on-one meetings to formal publications successfully, while small firms were not. This has real costs for small firms:

  • Small firms that lost analyst coverage after the adoption of Regulation FD experienced significant increases in the cost of capital.
  • A 2001 survey of the securities bar of the American Bar Association found that 67 percent of respondents believed Regulation FD had a greater impact on small and mid-cap companies that on large-cap companies.

Source: Carlos Lozada, "SEC Regulation FD Raises the Cost of Capital for Small Firms," NBER Digest, February 2005; based upon: Armando Gomes, Gary Gorton and Leonardo Madureira, "SEC Regulation Fair Disclosure, Information, and the Cost of Capital," National Bureau of Economic Research, Working Paper No. 10567, June 2004.

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