The Changing Information Environment and Disclosure De-regulation

In July 2005, the Securities and Exchange Commission (SEC) announced the enactment of the Securities Offering Reform (Reform), which, among other things, relaxes restrictions—known as ‘gun jumping’ provisions—on firms’ forward-looking disclosures prior to public equity offerings. The SEC argues that in recent years, the information environment has become much richer through marked improvements in mandated disclosure quality and both broader and timelier dissemination of information, rendering gun jumping provisions “unnecessary and outdated,” as these rules restrict valuable information flow to investors around a highly important corporate event (SEC [2005]). However, opponents of the Reform argue that the restrictions are meant to protect investors from managers conditioning the market (i.e., hyping the stock price) before incentive-rich corporate events such as equity offerings, and the relaxation of these restrictions will increase market conditioning.

In our paper, The Changing Information Environment and Disclosure De-regulation: Evidence from the 2005 Securities Offering Reform, which was recently made publicly available on SSRN, we examine the impact of the Reform on management forecasting behavior before equity offerings. To provide a broader context in which to evaluate this impact, we also investigate the effect of the recently improved information environment on market conditioning. Thus, this paper is comprised of three main analyses. First, using the enactment of SOX in 2002 as the shift in the information environment, we examine whether managers generally attempt to mislead the market using forecast announcements in the pre-SOX period. Using a difference in differences design, we find that there is a statistically significant increase in the propensity and magnitude of good news disclosures by SEO firms via management forecasts in the period before the SEO, as compared to those of non-SEO firms in the same industry and of similar size, growth, and performance. Moreover, we observe a negative association between the pre-SEO good news disclosure activity and long-term abnormal returns following the SEO. This suggests that in the less rich information environment pre-SOX, managers use forecast announcements to hype the stock price in the months prior to equity offerings.

Second, we explore the role that the improved information environment plays in preventing managers from misleading the market. We contend that if the information environment has become richer in recent years, investors should be able to better monitor managerial behavior. This intuition is grounded in a well-established disclosure literature that indicates that higher disclosure quality can reduce information asymmetry between managers and investors (Healy and Palepu [2001]). As a result of this increased transparency, managers are less able to mislead investors through disclosures, as investors are more likely to both better understand firm value and better assess the relevancy of firm disclosures with respect to that valuation. Thus, to the extent the information environment has improved, we should observe less hyping in the new disclosure regime. We find that the increase in good news disclosure activity in the pre-offering period observed in the pre-SOX period becomes muted in the post-SOX period. Further, the negative association between pre-offering disclosure activity and post-offering performance no longer holds in the post-SOX period. This is consistent with the information environment acting as a disciplining mechanism on managers’ market conditioning behavior.

Finally, we examine the effect of the 2005 Securities Offering Reform on managers’ forecasting behavior as well as the relation between pre-SEO forecasts and post-SEO returns. Given the Reform’s safe harbor and encouragement of forward-looking information, we also look at whether there was an increase in the number of management forecasts in the months prior to offerings. Consistent with the SEC’s intent, we find an increase in the number of forecasts given in the pre-SEO period; however, the propensity and magnitude of good news disclosures does not increase. In addition, we continue to find no evidence of market conditioning post-Reform, suggesting that managers are less able to hype their stock price via disclosures in the richer information environment. Overall, these results indicate that while managers may have engaged in market conditioning in earlier years (i.e., pre-SOX), these actions have been mitigated in a richer information environment, allowing the SEC to relax information constraints on firms before SEOs.

The full paper is available for download here.