by Brad Badertscher, Nemit Shroff and Hal White


In the wake of the 1929 stock market crash, Congress passed the Securities Acts of 1933 and 1934, which greatly increased the required amount of information that publicly-traded firms must disclose to investors. This increased transparency was intended to restore investor confidence in the firms and the market. Since then, regulators have continued to increase firms’ disclosure requirements. Public firms now disclose large amounts of information, such as their business strategy, financial performance, expected future outlook, current and future investment outlays, material contracts, and business risks. In addition, information intermediaries, such as financial analysts and the business press, analyze, discuss, and disseminate firms’ disclosures.
In contrast, private firms are not required to publicly disclose information in the U.S. and analysts and the business press provide much less coverage of private firms, little is known about the operations and performance of private firms. Thus, the composition of public and private firms in an industry is likely to have a significant effect on the industry’s information environment. While this increased transparency may be beneficial to investors in assessing firms’ financial health and future prospects, other market participants (e.g., industry peer firms) may also find the public disclosures useful.
In Badertscher, Shroff, and White (2013), we show that greater public firm presence in an industry can increase the responsiveness of firms’ investment to their investment opportunities (i.e., investment efficiency) by enriching the industry’s information environment. The intuition is that as more firms in an industry publicly disclose information and receive coverage by information intermediaries, a more complete perspective of the current economic environment and future outlook for the industry emerges. This reduction in industry uncertainty can then be used by peer firms in the industry to make more informed investment decisions. Corporate investment decisions are often characterized by some degree of irreversibility, i.e., investment expenditures are at least partially sunk, and cannot be costlessly undone once incurred (Pindyck, 1991). When investment decisions are irreversible, uncertainty makes firms more cautious and leads firms to take a ‘wait and see’ strategy, making them less responsive to their growth opportunities (Bloom, Bond, and Van Reenen, 2007; Julio and Yook, 2012). Our results suggest that greater public firm presence leads to lower uncertainty, and thus increases investment efficiency.
We then examine circumstances when public firm presence is likely to have a higher or lower effect on firms’ investment efficiency. We begin by exploring whether differences in the quality and quantity of information disclosed in the industry affect the extent to which public firm presence reduces uncertainty. If the firms and information intermediaries in an industry disclose less information or information that conceals economic performance, public firm presence is less likely to reduce uncertainty and facilitate the investment decisions of peer firms in such an industry. Accordingly, we predict and find that the relation between public firm presence and investment efficiency is stronger when the public firms have more informative earnings, provide more management forecasts, and are covered by more analysts. We also find that the effect of public firm presence on investment efficiency is greater in industries characterized by higher degrees of investment irreversibility, i.e., when investment decisions have higher sunk costs.
So, what does this mean for future disclosure regulation and its ability to generate positive externalities? Clearly there are well-documented costs and benefits to mandatory disclosure regulation. However the current movement is towards firms utilizing decreased disclosure-related regulation and/or leverage buyouts to avoid disclosure requirements, yet still maintaining access to capital and investors. For instance, among its many items, the JOBS (Jumpstart Our Business Startups) Act of 2012 significantly eased the regulatory burdens of firms complying with the registration and reporting obligations of the Securities Exchange Act of 1934, while still allowing firms to access additional capital through increased stockholders of record (from 500 to 2,000). In addition, the JOBS Act relieves “emerging growth companies” from certain regulatory and disclosure requirements when they initially go public and for a period of five years after they are public. As a result, the JOBS Act coupled with the growing leverage buyout market (WSJ, 12/6/2012) gives firms, both young and established, the ability to grow and raise capital without being subjected to mandatory disclosure requirements. Although such actions likely benefit the involved firm in a positive way, the ramifications also extend to the rest of the industry, as such actions will likely reduce the richness of the industry’s information environment. Our study suggests that this reduction in the information environment could lead to less informed investment decisions.
Another question arising from our research is, can society in general benefit from a full disclosure regime, where both private and public firms publicly disclose information? Perhaps we can learn something from the U.K., where both private and public firms are required to publicly disclose their financial statements. In our study, we compare changes in public firm presence in the U.S. with similar changes in the U.K. to determine whether our observed relation between public firm presence and investment efficiency holds in the U.K. Since the proportion of public firms does not capture the proportion of firms publicly disclosing information in the U.K., it is less likely to capture variation in the information environment of the industry as a whole. We find no evidence that public firm presence affects investment sensitivities of private firms in the U.K. While this finding further validates the inferences in our paper, it also poses an interesting question as to whether the lack of findings in the U.K. suggests that firms are already using the information to make more efficient investments.
As regulators increase disclosure requirements on public companies to serve investors, many more questions arise. Are the burdens of complying with disclosure rules driving more and more firms to delist? If so, what impact does that have on economic growth in an economy, both directly and indirectly through externalities? Should private firms be required to disclose information? To which constituency and what level of care should regulators be focused on? At a minimum, it seems that there should be more thorough discussion and analyses on the implications of disclosure regulation beyond how it directly impacts investors’ understanding of the firm.


1) Badertscher, B., N. Shroff, and H. White. 2013. Externalities of public firms: Evidence from private firms’ investment decisions. Forthcoming at Journal of Financial Economics.
2)  Bloom, N., Bond, S., Van Reenen, J., 2007. Uncertainty and investment dynamics. Review of Economic Studies 74, 391–415.
3)  Julio, B., Yook, Y., 2012. Political uncertainty and corporate investment cycles. The Journal of Finance 67(1), 45-84.
4)  Pindyck, R., 1991. Irreversibility, uncertainty, and investment. Journal of Economic Literature 29(3), 1110-1148.
5)  Wall Street Journal, December, 16 2012. Debt loads climb in buyout deals.