Redacting Proprietary Information at the Initial Public Offering

The U.S. Securities and Exchange Commission (SEC) mandates that publicly-traded firms disclose a large array of information to investors. Because certain disclosures could cause competitive harm, the SEC allows firms to request confidential treatment of competitively sensitive information contained in material agreements that it would otherwise be required to disclose to the public. If the SEC grants the request, the firm receives a Confidential Treatment Order (CTO), enabling them to redact specific content from their material, such as pricing terms, specifications, deadlines, and milestone payments. For the duration of time that the confidential treatment is awarded, which coincides with the length of the agreement, the redacted details are not subject to Freedom of Information Act (FOIA) requests. While a CTO shields proprietary information from competitors, it also prevents investors from obtaining potentially value-relevant information from SEC disclosures, which can be even more critical at the initial public offering (IPO) stage when it is often the first opportunity for the public to learn details about the firm.

In our paper, Redacting Proprietary Information at the Initial Public Offering, which was recently published in Journal of Financial Economics, we examine the prevalence and implications of these agreements for a sample of 2,199 firms conducting an IPO from 1996 through 2011. Using information contained in registration statements and accompanying exhibits, we document that approximately 40% of firms going public redact information from at least one material agreement at the IPO. Examination of firm characteristics shows that redacting firms are younger, have higher research and development expenses, receive venture capital backing, and reside in more competitive industries. These findings are consistent with the notion that IPO firms employing confidential treatment for material agreements from the SEC face higher proprietary costs from disclosing information to rival firms.

The decision to redact generates potential benefits by shielding competitively sensitive information, but comes with important trade-offs for the IPO firm and its pre-IPO owners. For example, by not revealing specific details, investors might have to incur higher information production costs, generate less precise valuation estimates or infer that the redacted content contains negative information (e.g., poor pricing terms on a key product). Consequently, firms likely incur pricing and other market capital market consequences when redacting information.

Indeed, redacting firms take on average 13 days longer to go public based on the initial registration filing date. Moreover, IPO firms with redacted information experience larger proportional first day underpricing than those with full disclosure, even after controlling for other factors associated with first-day price increases. We estimate that the magnitude of this effect is an approximately seven percentage point difference between the offer price and the close price on the first day of trading; the magnitude is large economically given that the mean underpricing is approximately 21%. This finding implies that reducing the precision of information can increase information asymmetries between managers and investors, leading to a higher cost of raising capital.

We also find that redacting firms are more likely to conduct follow-on offerings and raise proportionately more capital at these offerings relative to the IPO stage. This result suggests that executives rationally anticipate the increased capital costs from redacting, and attempt to offset those costs by issuing equity after investors have been able to observe the firm’s financial outcomes. Similarly, pre-IPO insiders at redacting firms sell their own shares at a slower rate than insiders at non-redacting firms. This decision likely has two effects. First, it helps certify that the redacted information contains proprietary information that helps maintain a competitive advantage rather than negative information that managers wish to hide. Second, slower selling can also help reduce the wealth transfers that executives would have faced if they had sold sooner after the IPO when investors were still unsure about the nature of the redacted information.

Redacting firms also exhibit greater idiosyncratic volatility than non-redacting firms in their first year after the IPO, which further confirms that redacting information creates more uncertainty about firm-specific prospects. This difference in idiosyncratic volatility remains during Years 2 and 3 after the IPO before disappearing by Year 4. These findings suggest that information asymmetries are higher for IPO firms with redacted information versus those that do not, and that the differences decline as investors observe firm outcomes over time.

Though the above results illustrate the costs to redacting, if shielding information helps maintain a competitive advantage, we expect that redacting firms would benefit. We find that IPO firms with redacted information have greater profitability, as measured by EBITDA-to-sales and ROA, and higher sales growth than industry peers in the three years following the IPO. The superior performance relative to peers illustrates that keeping proprietary information confidential helps generate positive economic outcomes.

Overall, our paper provides systematic evidence on the redaction of information from SEC filings by IPO firms. At first glance, the large fraction of firms choosing to withhold information from material agreements is surprising given the adverse effects on IPO pricing and the firm’s post-IPO information environment. However, we document that redacting firms exhibit higher peer-adjusted financial performance, and that both firms and insiders choose to delay a portion of equity raising until after the firm has been public for some time. Thus, our study provides empirical evidence of the trade-offs firms face when going public between competitive needs to protect proprietary information from rivals and investors’ need for information to help value securities.

The full paper is available for download here.