The U.S. Securities and Exchange Commission’s Regulation Fair Disclosure (FD) has meant higher costs for capital for smaller firms, according to a report from the National Bureau of Economic Research.

Regulation FD, which was designed to combat selective disclosure by corporations to analysts and favoured investors has long been controversial. “Supporters argued that selective disclosure was unfair and undermined the integrity of financial markets, while detractors asserted that the flow of information between firms and investors would deteriorate without it,” NBER notes.

In the paper, co-authors Armando Gomes, Gary Gorton, and Leonardo Madureira examine the impact of Regulation FD on the production and transmission of information in financial markets, on security prices, and the cost of capital. NBER reports that the authors analyze the effects of Regulation FD on analyst following, firms’ use of pre-announcements, and forecast errors and volatility at earnings announcements.

“Our main finding,” explain the authors, “is that there was a reallocation of information-producing resources and that this reallocation had asset-pricing effects.” Specifically, NBER says they found that on average small firms lost 17% of their analyst following after the adoption of Reg FD, while large firms increased their following by 7%.

As well, small firms experienced higher forecast errors and more volatile market responses to their earnings announcements, NBER notes.

The study also found that large firms became almost twice as likely to make voluntary earnings announcements, whereas small firms did not significantly increase their voluntary announcements.

NBER says that the paper shows that, “increases in the costs of producing information affected the asset prices of small firms; in particular, the stocks of small firms that lost analyst coverage after the adoption of Regulation FD experienced significant increases in the costs of capital”.

“Overall, our results suggest that Regulation FD had unintended consequences and that ‘information’ in financial markets may be more complicated than current finance theory admits,” they conclude.

http://www.nber.org/digest/feb05/w10567.html