00:00:05
what we do in the in our in our research
00:00:07
paper is we look at the ipo market so
00:00:10
firms that aren't publicly traded yet uh
00:00:12
but are going public on the new york
00:00:14
stock exchange or the or the nasdaq
00:00:17
and we look at the price that they go
00:00:19
public at
00:00:20
and sort of their future returns and the
00:00:23
volatility or risk associated with those
00:00:25
companies
00:00:26
and then we correlate those measures
00:00:29
with
00:00:30
the amount of disclosure that the firm
00:00:33
has
00:00:34
at the time of its if it's of its ipo so
00:00:37
there was a recent rule that came out
00:00:39
back in 2012 called the jobs act
00:00:42
and the jobs act allowed firms to reduce
00:00:45
the amount of information that they
00:00:46
provide to investors
00:00:48
so you know a lot of your your viewers
00:00:51
your readers are probably familiar with
00:00:52
you know
00:00:53
sec filings you've got to file an sec
00:00:55
financial statements all these all these
00:00:57
sorts of accounting accounting
00:00:59
statements
00:01:00
what the jobs act does is it reduces the
00:01:02
amount of information
00:01:04
that the firm is required to provide to
00:01:06
the equity market before going public
00:01:08
and a natural question is
00:01:11
when you reduce the amount of
00:01:12
information are you increasing sort of
00:01:14
the risk of the company how do investors
00:01:16
respond to that and so we try and answer
00:01:18
that
00:01:19
answer that question by looking at to
00:01:21
see what actually happens after the
00:01:22
regulation
00:01:27
what we end up finding in the in the
00:01:29
study
00:01:30
is that after the jobs act
00:01:33
the ipos that are going public are
00:01:35
actually substantially riskier
00:01:38
so
00:01:39
if you just think about imagining a
00:01:40
world in which the sec requires all of
00:01:43
the ipos to go through a screening
00:01:45
process
00:01:46
and issue these mandatory disclosures
00:01:48
and then
00:01:50
the legislative branch of government
00:01:52
comes along and says well you know let's
00:01:54
actually sort of scale that back let's
00:01:56
only require them to do two years worth
00:01:58
of screening as opposed to the prior
00:02:00
three years
00:02:01
so you can imagine that that's going to
00:02:02
have the effect of potentially bringing
00:02:05
different companies to the market
00:02:07
so the analogy would be you know you go
00:02:09
to a used car lot
00:02:11
and suppose the government requires that
00:02:13
when you purchase the used car the car
00:02:15
dealer has to give you basically a spec
00:02:18
sheet on what the car's you know been
00:02:20
doing what the car's life was and then
00:02:22
the government comes along and says well
00:02:24
we're not going to require that anymore
00:02:26
car dealers can do it voluntarily
00:02:28
so now when you go to the car dealer
00:02:30
there's some you know some cars have the
00:02:33
spec sheet and other cars don't have the
00:02:35
spec sheet
00:02:36
what do you infer about the cars that
00:02:38
don't offer you or the car dealers that
00:02:40
don't offer you the spec sheet and so
00:02:42
this is what we call a lemons problem
00:02:45
where you have sort of companies that
00:02:47
aren't disclosing as much anymore and
00:02:49
the question is why are they not
00:02:51
disclosing much anymore because now
00:02:53
you've taken a mandatory rule and you've
00:02:54
made it and you've made it voluntary and
00:02:56
we find that those companies that don't
00:02:57
disclose you know are indeed much much
00:03:00
uh much riskier
00:03:02
and so that's sort of the sort of the
00:03:04
key punchline of the study is when you
00:03:06
observe a firm scale back its disclosure
00:03:08
they're doing that for a reason
00:03:10
and investors sort of become more
00:03:13
uncertain and that generates risk for
00:03:14
the company
00:03:19
we were actually surprised by the
00:03:21
magnitude of the effect that we saw um
00:03:24
you know there's really two two schools
00:03:26
of thought when it comes to you know
00:03:28
reduction in disclosure one school of
00:03:29
thought is that you know government
00:03:31
requirements and regulations for
00:03:33
disclosure are burdensome on firms and
00:03:35
so they're excessively costly you have
00:03:37
to hire lawyers you have to hire
00:03:39
accountants you have to hire auditors
00:03:41
you know to go over and to scrutinize
00:03:43
your financial statements
00:03:45
and the purpose of the jobs act at least
00:03:47
the stated purpose by the proponents was
00:03:49
to reduce that cost and to allow more
00:03:52
small businesses
00:03:53
to go public because now they don't have
00:03:55
to pay as much fees to lawyers and to
00:03:57
accountants and to
00:03:59
and so we expected to see some effect
00:04:01
because you're going to see smaller
00:04:02
firms entering the ipo market and
00:04:04
naturally those smaller firms will be
00:04:06
riskier
00:04:07
but we were surprised at the magnitude
00:04:09
of the effect that we found for even
00:04:12
very large firms so it wasn't just the
00:04:14
small firms that were taking advantage
00:04:16
of these provisions it was also the you
00:04:18
know the firms well with a billion
00:04:20
dollars in revenue and even there we
00:04:22
found a substantial uh substantial
00:04:24
effect on the order to uh on the order
00:04:26
of six to 12 percent uh change in in
00:04:29
what we call ipo under pricing uh and uh
00:04:32
i think a five percent uh shift in
00:04:34
equity volatility which is you know in
00:04:36
the grand scheme of things that's a
00:04:38
substantial uh substantial cost of the
00:04:40
company even though it's not explicit
00:04:43
so you know back to my uh to my earlier
00:04:45
uh
00:04:46
you know remark about the the used car
00:04:48
lot
00:04:49
now you have a situation where the used
00:04:52
car salesman is two cars both red same
00:04:54
makes same model one comes with the
00:04:56
disclosure of its history one doesn't
00:04:58
the used car salesman can't sell the car
00:05:01
that doesn't come with the disclosure
00:05:03
for the same price as the car that comes
00:05:04
with the disclosure so he marks the
00:05:06
price of the car without the disclosure
00:05:08
down and so what we're measuring in our
00:05:10
study is how much
00:05:12
the bankers mark down the price of firms
00:05:14
that don't have the disclosure and that
00:05:16
looks like between a six and 12 percent
00:05:18
discount and that's a substantial amount
00:05:20
when you're thinking about a
00:05:20
multi-million dollar company so that's a
00:05:22
specific cost of the jobs act even
00:05:24
though it's not an explicit
00:05:26
cost it's not you know saving money on
00:05:28
underwriters
00:05:33
well i think until our study there
00:05:35
hadn't really been any evidence on what
00:05:38
the effect of the jobs act was on the
00:05:41
amount that or the amount that the firm
00:05:42
could raise on under pricing or on
00:05:44
volatility and so if you actually look
00:05:46
at what the ceos are saying in the
00:05:48
popular press a lot of ceos are coming
00:05:50
out
00:05:51
in favor of it especially the the tech
00:05:53
companies so twitter was uh was one
00:05:55
company who took advantage of this and
00:05:57
what they're saying is you know it's
00:05:59
saving us lots of money in terms of you
00:06:02
know we don't have to hire lawyers we
00:06:03
don't have to hire accountants we don't
00:06:04
have to have people prepare the you know
00:06:06
as many years of financial statements
00:06:08
and so we can save in terms of the
00:06:10
explicit costs of preparing our
00:06:12
disclosures with the sec
00:06:15
the problem with that sort of reasoning
00:06:17
is is it ignores the implicit costs
00:06:20
right so if i have these two cars and
00:06:22
they're both red they're both the same
00:06:25
make and the same model
00:06:27
one comes with a disclosure of the car's
00:06:28
history the other one doesn't i can't
00:06:31
sell
00:06:32
the car that doesn't come with the
00:06:33
disclosure for the same price
00:06:35
so i could sell both cars for 5 000 that
00:06:38
one car i can't sell for 5000 because it
00:06:40
doesn't come with a disclosure i can
00:06:41
only sell it for 4 500. so that you can
00:06:44
think of as the difference between those
00:06:45
two is a 500
00:06:47
implicit cost
00:06:48
so what we're finding is is that while
00:06:50
the jobs act is saving money on
00:06:52
uh sort of preparation costs and is
00:06:55
allowing smaller firms to go public
00:06:57
because those firms no longer have these
00:07:00
burdensome explicit costs it's actually
00:07:03
increasing the indirect costs because
00:07:06
firms can't go ipo for the same prices
00:07:09
that they could have before they can't
00:07:10
raise as much money
00:07:12
when they disclose less and so that
00:07:14
creates an indirect cost
00:07:16
that i think many practitioners and many
00:07:18
managers aren't necessarily taking into
00:07:20
account when they're making the
00:07:21
trade-off about should they reduce their
00:07:23
disclosure under the jobs act
00:07:29
so let's take the the company first um
00:07:32
so what the company's concerned about is
00:07:33
presumably the company wants to maximize
00:07:35
its ipo offer price they want to get
00:07:37
they want to sell the company for as
00:07:39
much as they possibly can on the public
00:07:41
market so let's take let's just assume
00:07:43
that that's the objectives of the
00:07:44
managers and that they're benevolent and
00:07:46
that's what they're trying to do
00:07:47
so what we find is that the discount
00:07:49
that investors apply to firms who are
00:07:52
taking advantage of these reduced
00:07:53
disclosure regulations is about a six to
00:07:56
eight percent discount and you know
00:07:58
sometimes it even goes as high as 12.
00:08:01
so for example if a firm is going public
00:08:04
perhaps it might be able to raise 100
00:08:06
let's say hypothetically 100 million
00:08:08
dollars in its ipo
00:08:09
with a six to eight percent discount
00:08:12
it's only going to be able to raise say
00:08:15
92 or 94 of that which means it will
00:08:18
only be able to raise say 92 million
00:08:21
so the indirect cost of the reduced
00:08:23
disclosure for that firm is about eight
00:08:26
million
00:08:27
dollars you know between six and twelve
00:08:28
let's just pick eight because it's in
00:08:29
the middle so they have to trade off
00:08:31
that eight million dollar discount that
00:08:33
investors apply
00:08:34
against the savings that they get from
00:08:37
you know not having to prepare
00:08:39
additional disclosures
00:08:41
right so you know add up all of the
00:08:43
costs that you would pay for additional
00:08:44
year of audited financial statements for
00:08:46
additional year of you know litigation
00:08:47
protection from your lawyers and whatnot
00:08:50
and see if it comes out to about you
00:08:51
know
00:08:52
between six to 12 percent of what you
00:08:54
think your market value should be
00:08:58
that's under the story of the firm or
00:09:00
the managers being benevolent and having
00:09:02
shareholders interests in mind and
00:09:03
trying to sell the firm for the highest
00:09:05
price another story which is more
00:09:07
cynical
00:09:09
is that one of the reduced disclosures
00:09:11
is that they the firm no longer has to
00:09:13
disclose the compensation of the top
00:09:16
five executives it just has to disclose
00:09:18
compensation for three executives
00:09:21
so another thing that the firm can do
00:09:22
under this sort of legislation is that
00:09:25
you know it can reduce the amount of
00:09:27
information that it provides to the
00:09:28
market about compensation
00:09:30
so on the one hand that might shield the
00:09:33
firm from sort of um unjust public
00:09:36
criticism of how lucrative the
00:09:38
compensation deal is
00:09:40
which could be a good thing but if that
00:09:43
compensation is excess compensation if
00:09:45
the ceo and the top five guys are being
00:09:47
paid too much the market wouldn't
00:09:49
actually know that at the time that the
00:09:51
that the firm goes goes public so from
00:09:53
the company's perspective if they're
00:09:54
trying to maximize their offer price
00:09:57
they need to trade off the explicit cost
00:09:59
which is the savings and the litigation
00:10:01
the accountants and whatnot versus the
00:10:02
indirect cost and our paper is really
00:10:04
about the indirect cost which is this
00:10:06
somewhere between six and twelve percent
00:10:08
discount so that's sort of what they
00:10:10
need to uh to take into account so
00:10:12
that's a new cost
00:10:13
of going public that wasn't there uh
00:10:15
previously
00:10:18
for the investors side let's we could
00:10:20
think about this as there being sort of
00:10:21
two broad types of investor investors
00:10:24
sophisticated investors and
00:10:26
unsophisticated investors
00:10:28
let's take unsophisticated investors
00:10:30
first these are the people who
00:10:32
um you know maybe they have a cursory
00:10:35
knowledge of financial statements and
00:10:36
accounting information if that
00:10:39
and one can argue whether
00:10:41
unsophisticated investors should even be
00:10:43
taking part in the ipo or not but let's
00:10:46
just assume that there are some
00:10:47
unsophisticated investors who are sort
00:10:50
of investing in ipos we certainly saw
00:10:52
that during the during the tech bubble
00:10:54
of the of the 2000s
00:10:56
these investors are getting less
00:10:58
information from the firm
00:11:00
so
00:11:01
relative to the sophisticated investors
00:11:04
we think that they're actually worse off
00:11:06
because the sophisticated investors can
00:11:08
make up for any lack in public
00:11:10
information by collecting private
00:11:12
information whereas unsophisticated
00:11:15
investors they can't go out there and
00:11:17
collect private information you can
00:11:19
think of
00:11:20
you know like your grandmother or your
00:11:22
mom or your dad being one of these sort
00:11:24
of unsophisticated unsophisticated
00:11:27
investors with rudimentary understanding
00:11:29
they may or may not even realize that
00:11:31
the amount of public disclosure that the
00:11:33
firm is providing has shrunk
00:11:36
what that means is that the
00:11:38
sophisticated investors let's talk about
00:11:40
you know
00:11:40
the big investment banks the the
00:11:42
underwriters
00:11:44
they can get all of the information that
00:11:45
they want from uh you know from either
00:11:48
other sources or from the firm
00:11:51
so their information set we think is
00:11:53
generally unchanged whereas what's
00:11:55
changing is the information set of the
00:11:57
unsophisticated investor
00:11:58
and this is one reason why we think the
00:12:00
sec was pushing back on on making these
00:12:02
new rules that congress mandated them to
00:12:04
do because the sdc's mission is really
00:12:06
to protect the individual investor
00:12:08
and anytime you have a reduction in the
00:12:11
amount of public information
00:12:14
individual investors generally do
00:12:15
generally do worse this is why we had
00:12:18
these rules in the first place
00:12:20
to you know mandate firms to disclose as
00:12:22
much as they could so let's go back to
00:12:25
the car example
00:12:26
you've got an auto mechanic who's going
00:12:29
to the you know to the car dealership
00:12:31
lot he's your sophisticated investor he
00:12:33
sees the two cars they're the same makes
00:12:35
same model same color sees one with the
00:12:37
disclosure sees the other one without
00:12:40
the disclosure right
00:12:42
he can detect without the disclosure
00:12:45
whether that that from that car that
00:12:48
doesn't have the disclosure is actually
00:12:50
a good car or not
00:12:51
whereas you know if i go to the used car
00:12:54
car a lot
00:12:55
i would not be able to tell the
00:12:56
difference between a good car and a bad
00:12:57
car i'm going to rely on the disclosure
00:12:59
to tell me that so sophisticated
00:13:02
investors don't rely on the disclosures
00:13:04
as much as the unsophisticated investors
00:13:06
and so sophisticated investors aren't
00:13:07
hurt as much when the disclosure gets
00:13:09
removed
00:13:14
i want to be clear the jobs act has many
00:13:16
many different titles and covers more
00:13:18
than just disclosure by ipo firms it
00:13:20
does a lot of different things it
00:13:23
you know changes the rules for
00:13:24
crowdsourcing and crowdfunding of of
00:13:27
projects and so there's a lot of
00:13:28
different faces of the jobs act that we
00:13:31
don't really examine we just picked out
00:13:32
this sort of one provision or one title
00:13:35
of the jobs act and examined that's that
00:13:38
its effect so i don't want to say that
00:13:41
you know the entirety of the act
00:13:43
um is necessarily harmful or or
00:13:45
beneficial we're just picking one little
00:13:47
aspect of the act and looking at how
00:13:49
that affected the sort of the ipo market
00:13:52
and documenting that there are perhaps
00:13:53
unintended consequences
00:13:55
or maybe even intended consequences of
00:13:58
the uh
00:13:59
of the act what's next i think is you
00:14:01
know the act has been relatively new uh
00:14:03
so the body of literature is just
00:14:05
starting
00:14:06
there's only one published paper on the
00:14:08
jobs act you know i have this paper and
00:14:10
there's a couple others that are that
00:14:11
are just starting up
00:14:12
but you know anytime you have a firm
00:14:14
that reduces or chooses to reduce the
00:14:16
amount of information it provides
00:14:18
whether it be about its compensation
00:14:20
arrangements with its executives whether
00:14:22
it be about its accounting performance
00:14:25
whether it be about you know management
00:14:27
discussion and analysis you know that's
00:14:29
going to have a ripple effect on all
00:14:31
kinds of other intermediaries that rely
00:14:33
on public information so are now credit
00:14:36
rating agencies going to have to you
00:14:38
know to rely on different sets of
00:14:40
information are
00:14:41
equity analysts going to have to rely on
00:14:43
different sets of information
00:14:45
so you know we just looked at you could
00:14:46
think of like the market consequences
00:14:48
how it gets into price and how it gets
00:14:49
into volatility but we haven't actually
00:14:51
looked at well how does it affect all of
00:14:53
these different intermediaries
00:14:55
that are relying on the firm's
00:14:58
disclosures and public information and
00:15:00
so i think that's where sort of the next
00:15:02
step would be for examining sort of the
00:15:04
first two titles of the of the jobs act
00:15:06
which is what we do which is about a
00:15:08
reduction a reduction in disclosure
00:15:33
you
