The Essential Role of Securities Regulation

This Article posits that the essential role of securities regulation is to create a competitive market for sophisticated professional investors and analysts (information traders). The Article advances two related theses-one descriptive and the other normative. Descriptively, the Article demonstrates that securities regulation is specifically designed to facilitate and protect the work of information traders. Securities regulation may be divided into three broad categories: (i) disclosure duties; (ii) restrictions on fraud and manipulation; and (iii) restrictions on insider trading-each of which contributes to the creation of a vibrant market for information traders. Disclosure duties reduce information traders\u27 costs of searching and gathering information. Restrictions on fraud and manipulation lower information traders\u27 cost of verifying the credibility of information, and thus enhance information traders\u27 ability to make accurate predictions. Finally, restrictions on insider trading protect information traders from competition from insiders that would undermine information traders\u27 ability to recoup their investment in information. Normatively, the Article shows that information traders can best underwrite efficient and liquid capital markets, and, hence, it is this group that securities regulation should strive to protect. Our account has important implications for several policy debates. First, our account supports the system of mandatory disclosure. We show that, although market forces may provide management with an adequate incentive to disclose at the initial public offering (IPO) stage, they cannot be relied on to effect optimal disclosure thereafter. Second, our analysis categorically rejects calls to limit disclosure duties to hard information and self-dealing by management. Third, our analysis supports the use of the fraud-on-the-market presumption in all fraud cases even when markets are inefficient. Fourth, our analysis suggests that in cases involving corporate misstatements, the appropriate standard of care should, in principle, be negligence, not fraud

The Essential Role of Securities Regulation

This Article posits that the essential role of securities regulation is to create a competitive market for sophisticated professional investors and analysts (information traders). The Article advances two related theses-one descriptive and the other normative. Descriptively, the Article demonstrates that securities regulation is specifically designed to facilitate and protect the work of information traders. Securities regulation may be divided into three broad categories: (i) disclosure duties; (ii) restrictions on fraud and manipulation; and (iii) restrictions on insider trading-each of which contributes to the creation of a vibrant market for information traders. Disclosure duties reduce information traders\u27 costs of searching and gathering information. Restrictions on fraud and manipulation lower information traders\u27 cost of verifying the credibility of information, and thus enhance information traders\u27 ability to make accurate predictions. Finally, restrictions on insider trading protect information traders from competition from insiders that would undermine information traders\u27 ability to recoup their investment in information. Normatively, the Article shows that information traders can best underwrite efficient and liquid capital markets, and, hence, it is this group that securities regulation should strive to protect. Our account has important implications for several policy debates. First, our account supports the system of mandatory disclosure. We show that, although market forces may provide management with an adequate incentive to disclose at the initial public offering (IPO) stage, they cannot be relied on to effect optimal disclosure thereafter. Second, our analysis categorically rejects calls to limit disclosure duties to hard information and self-dealing by management. Third, our analysis supports the use of the fraud-on-the-market presumption in all fraud cases even when markets are inefficient. Fourth, our analysis suggests that in cases involving corporate misstatements, the appropriate standard of care should, in principle, be negligence, not fraud

Audit committees and accuracy of management earnings forecasts of Malaysian IPOs

This study aims to make a meaningful contribution to the IPO literature by examining the impact of audit committee characteristics on the accuracy of earnings forecasts in 190 Malaysian IPO prospectuses during the period of 2002-2012. This study also adds to the body of knowledge by investigating the accuracy of IPO earnings forecasts during the former mandatory earnings forecasts (January 2002 to January 2008) and the current voluntary earnings forecasts (February 2008 to February 2012). Furthermore, it explores the provided explanations in the first published annual reports after IPO, which explain the reasons behind the errors of earnings forecasts. Two proxies were used for accuracy; absolute forecast error and squared forecast error. The models were developed using the frameworks of the agency theory, the signaling theory, and the resource-dependence theory to examine the association of eight characteristics of the audit committee (size, independence, financial expertise, gender diversity, ethnicity, stock ownership, educational background, and experience) with the accuracy of IPO earnings forecasts. The findings indicate that the earnings forecasts of Malaysian IPO are pessimistic and the percentage of accuracy is unsatisfactory. Further, the results show that Malaysian IPO earnings forecasts have been more pessimistic and less accurate under the voluntary regulation regime than the mandatory regime. The findings of multiple regressions of the audit committee and absolute forecast error show significant relationships with positive impacts among size, experience and accuracy of earnings forecasts. In terms of the findings of multiple regressions of the audit committee and the squared forecast error, the results show significant relationships with positive impacts between size and earnings forecasts accuracy. Finally, the results indicate that the number of provided explanations was greater when the management were more optimistic and the forecasts errors were large. The results of this study can be of interest to investors, policymakers, investment analysts and other market participant

The Economics of Conflicts of Interest in Financial Institutions

A conflict of interest exists when a party to a transaction could potentially make a gain from taking actions that are detrimental to the other party in the transaction. This paper examines the economics of conflicts of interest in financial institutions and reviews the growing empirical literature (mostly focused on analysts) on the economic implications of these conflicts. Economic analysis shows that, although conflicts of interest are omnipresent when contracting is costly and parties are imperfectly informed, there are important factors that mitigate their impact and, strikingly, it is possible for customers of financial institutions to benefit from the existence of such conflicts. The empirical literature reaches conclusions that differ across types of conflicts of interest, but overall these conclusions are more ambivalent and certainly more benign than the conclusions drawn by journalists and politicians from mostly anecdotal evidence. Though much has been made of conflicts of interest arising from investment banking activities, there is no consensus in the empirical literature supporting the view that conflicts resulting from these activities had a systematic adverse impact on customers of financial institutions.

SPAC Mergers, IPOs, and the PSLRA\u27s Safe Harbor: Unpacking Claims of Regulatory Arbitrage

Communications in connection with an initial public offering (IPO) are excluded from the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 (PSLRA). Unsurprisingly, IPO issuers do not share projections publicly-—the liability risk is too great. By contrast, communications in connection with a merger are not excluded from the safe harbor, and special purpose acquisition companies (SPACs) routinely share their merger targets’ projections publicly. Does the divergent application of the PSLRA’s safe harbor in traditional IPOs and SPAC mergers create an opportunity for “regulatory arbitrage” and, if so, what should be done about it? This Article offers a framework for evaluating these timely questions and for evaluating claims of regulatory arbitrage more broadly. The analysis brings into sharp focus the contestable policy choices that undergird the IPO exclusion to the PSLRA’s safe harbor

SPAC Mergers, IPOs, and the PSLRA\u27s Safe Harbor: Unpacking Claims of Regulatory Arbitrage

Communications in connection with an initial public offering (IPO) are excluded from the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 (PSLRA). Unsurprisingly, IPO issuers do not share projections publicly—the liability risk is too great. By contrast, communications in connection with a merger are not excluded from the safe harbor, and special purpose acquisition companies (SPACs) routinely share their merger targets’ projections publicly. Does the divergent application of the PSLRA’s safe harbor in traditional IPOs and SPAC mergers create an opportunity for “regulatory arbitrage” and, if so, what should be done about it? This Article offers a framework for evaluating these timely questions and for evaluating claims of regulatory arbitrage more broadly. The analysis brings into sharp focus the contestable policy choices that undergird the IPO exclusion to the PSLRA’s safe harbor

ON THE JOURNEY OF OVERSEAS LISTING: AN EMPIRICAL ANALYSIS ON CHINESE ENTERPRISES TO LIST ON THE HONG KONG STOCK EXCHANGE

The thesis, empirically investigates issues pertinent to the partial privatization of Chinese initial public offerings at home and abroad, especially on issues relating to Chinese enterprises‘ seeking overseas listings. Based on the asymmetric information hypotheses on initial public offerings (IPOs) and cross-border flotation literature, the proposed research includes both short-run and long-run methods, and covers the entire offering process of Chinese firms‘ going public in overseas markets. The investigation begins with an overview of Hong Kong‘s and China mainland‘s financial markets in Chapter II. The limitation of development in the domestic capital market, the desire of bringing Chinese SOEs into the international market, and the appropriate conditions in Hong Kong encourage Chinese companies to issue new shares in Hong Kong. Chapter III provides a comparative analysis on underpricing of Chinese and non-Chinese firms in Hong Kong, in order to discover the influence of asymmetric information on overseas listing and the correspondent offering strategies of Chinese companies and their underwriters. They are normally underwritten by highly reputable bankers, and the overwhelming majority of Chinese firms went public via bookbuilding when the market is on an optimal evaluation base. The average price range seems to be relatively conservative for promoting subscription demands. The potential loss can be partially mitigated by a positive price revision and carefully market timing. Chapter IV focuses on information disclosure and earnings forecasting accuracy in IPO prospectuses with their subsequent effects on aftermarket performance, since the accuracy of information becomes important in influencing IPOs offerings and after-market performance. The IPO profit forecasts errors represent a pessimistic bias on average, but it can be a crucial information resource for their investment decisions. The magnitude of forecasting errors is higher for China-related companies than local shares, indicating a higher asymmetric information level. The forecasts are not rational in the sense that managers correctly incorporate all available information, especially historical profits, in their forecasting. Also, the magnitude of forecasting errors can systematically affect the one-year trading performance. Due to the initial overvaluation, firms with higher initial returns actually underperform in the long run. And Chapter V, in order to discover the ultimate meanings and motives of such overseas listing, directly questions why and how the Chinese government takes so many many state-owned enterprises (SOEs) public in the international market. It concludes Chinese SOEs‘ overseas primary listing takes on the formidable tasks of macroeconomic partial privatization, home market protection, and domestic infantile market development. Large and ‗healthy‘ state-owned enterprises (SOEs) within the government‘s supporting industries are more likely to issue their shares on foreign, open, and well-developed stock exchanges when the target market is in good time of pricing and offering, in order to raise more capital, to operate under international standards, to send a positive signal of Chinese economic reform, and to indirectly protect the development of domestic financial market. Consequently, the partial privatization through an overseas primary listing approach is indeed a feasible way to facilitate domestic financial market growth, particularly for countries with a large economy but lack of a well-developed home capital market and a mature trading platform

Beyond balance sheet minimum requirements

Corporate disclosure consists of mandatory periodic disclosure and voluntary disclosure. Both contribute to the reduction of information asymmetries arising between the company and the current and/or potential investors, and between the company and other users. The compulsory information is prescribed by current applicable regulations and accounting standards, and refers to periodic financial reports. Further, companies have at their disposal several channels to communicate additional information to the public on a voluntary basis (e.g. conference calls, road shows and press releases). Concerning mandatory disclosure, the balance sheet is one of the fundamental financial statements for all companies, including firms undertaking Initial Public Offerings (IPOs). IPO prospectuses are the first means for firms willing to quote on capital markets to disclose financial information to the public. Several determinants may influence the level of disclosure, measured in terms of disclosed balance sheet items, in IPO prospectuses. Moreover, the extent of disclosure may affect investors’ ability to value the IPO. Based on a sample of 683 IPOs completed between 2003 and 2012, the results suggest that post-crisis firms and companies with a greater time distance between S-1 and 424 filings present a greater level of detailed information concerning their liabilities. In addition, firms operating in the ‘Oil, Gas and Coal’ industry present a greater disclosure level compared to the other industry types. Further analyses indicate that firstday returns are negatively affected by noncurrent assets and positively influenced by noncurrent liabilities.ope

Analyst coverage in IPO market and use of non-GAAP earnings in the prospectus

The disclosure of non-GAAP earnings measures is a common form of voluntary corporate disclosure among firms involved in an initial public offering (IPO) process. Using a sample of 21,004 analyst EPS forecasts calculated for 691 US IPOs completed between 2003 and 2012, it is examined how financial analysts perceive non-GAAP earnings information provided by managers in the prospectus filed with the SEC. In particular, it is investigated whether IPO firms that disclose also non-GAAP earnings in the prospectus receive analyst coverage earlier compared to IPO firms that disclose only GAAP earnings

Technology, Information Production, and Market Efficiency

A well functioning securities market relies on the availability of accurate information, a broad base of investors who can process this information, legal protection of these investors’ rights, and a liquid secondary market unencumbered by excessive transaction costs or constraints. When these conditions are satisfied, securities markets are likely to be broader and more efficient, with felicitous consequences for investment and resource allocation. This paper explores the effect of technological advances on these features of the market, emphasizing the incentives facing the producers of financial information.