Hard and Soft Information: Firm Disclosure, SEC Letters, and the JOBS Act
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1 Hard and Soft Information: Firm Disclosure, SEC Letters, and the JOBS Act Sudip Gupta and Ryan D. Israelsen Indiana University Second Annual Conference on the Regulation of Financial Markets Friday, May 1, 2015
2 GAME CHANGER 2
3 THEME How does the Jumpstart Our Business Startups (JOBS) Act affect disclosures of hard and soft information and IPO outcomes? 3
4 MOTIVATION Disclosure of information can: financial efficiency & the cost of capital (Edmans, et al. 2015, Easley and O Hara, 2004) Hard and Soft Information (Petersen, 2004) Hard Information (e.g., accounting data) is Credible but Costly to Produce Soft Information (e.g., discussion of accounting data) Less Costly to Produce but Less Credible Optimal mix depends on relative tradeoffs JOBS Act relaxed (binding?) constraints on disclosures of Hard Information change hard info. Optimal mix Firms should also change disclosures of soft Information Market responds
5 QUESTIONS PREVIEW OF RESULTS 1. How do firms disclosures of hard and soft information differ under the JOBS Act? Reduction in disclosure of hard information Change in disclosure of soft information 2. How does the information produced by the SEC change? Produces more information Soft information is more uncertain and negative in tone 3. How does the market respond? Underpricing Only soft info: firm & SEC Informed Trading both hard and soft info. Liquidity Both hard and soft info. 4. What are the benefits of optimal disclosure of soft information? Relative to a counterfactual, underpricing reduced by 2.7% Relative to a counterfactual, Bid-Ask spreads reduced by 1 cent 5
6 JOBS ACT (APRIL 5, 2012) Aim: Improve access to the public capital markets for Emerging Growth Companies (EGCs) Title I: Reduces financial disclosures 2 years (vs. 3) of audited financial statements 3 years (vs. 5) of selected financial data Reduces disclosure of executive compensation Compensation of 3 (vs. 5) key executives May omit a written discussion Allows the use of private accounting standards following IPO Confidential Submission Process (and possibly withdrawal) Testing the Waters Exemption form internal controls audit 6
7 LITERATURE Disclosure and Efficiency: Verrecchia (2001), Dye (2001), Easley and O Hara (2004), Petersen (2004), Edmans, Heinle, and Huang (2013), Impact of JOBS Act: Dambra, Field, and Gustafson (2014), Chaplinsky, Hanley, and Moon (2014), Barth, Landsman, and Taylor (2014), Dambra, Field, Gustafson, and Pisciotta (2014) Soft information and IPOs: Hanley and Hoberg (2010, 2012), Loughrin and McDonald (2013) Topic models: Ball, Hoberg and Maksimovic (2014), Hoberg and Lewis 7 (2014), Huang et al. (2014)
8 DATA ( ) IPO firms with Revenues < $1B 129 pre-jobs Act IPOs 156 JOBS Act EGCs Firm Characteristics (SDC Platinum, IPO filings) Underpricing, Probability of Informed Trading (PIN), Liquidity From registration statement/sec Edgar: Firm hard information: # years of audited accounting statements # years of selected financial data # of key executives w/ compensation data Private accounting standards? Written discussion of executive compensation? 8
9 DATA (CONTINUED) From registration statement/sec Edgar: Firm Soft information: Confidential Draft Registration Statement? Extract Risk Factors using a Topic model LDA SEC Soft information: From 1 st Comment Letter to IPO Firm: Pages Items Numbers Using Loughran & McDonald Dictionary: Uncertainty words/total words Weak modal words/strong modal words Negative words/positive words 9
10 BACKGROUND 10
11 HOW DO FIRMS DISCLOSURES CHANGE? 11
12 RISK FACTOR EXAMPLES 12
13 DISCLOSED RISK FACTORS Low tech vs High tech (Non-bio) high tech vs Bio-tech 13
14 HOW DO FIRMS DISCLOSURES CHANGE? Propensity Score Matching Match on: Offer Size Revenues Assets R&D VC Backing Star Underwriter High-Tech Industry JOBS Act Firms Disclose: Relatively fewer high-tech risks Relatively fewer pharmaceutical high-tech (vs. other high tech) 14
15 HOW DO FIRMS DISCLOSURES CHANGE? CORRELATIONS 15
16 SEC COMMENT LETTER TO QUALYS, INC
17 SEC COMMENT LETTER TO QUALYS, INC
18 HOW DO SEC COMMENT LETTERS CHANGE? 18
19 HOW DO INVESTORS REACT? UNDERPRICING 19
20 HOW DO INVESTORS REACT? UNDERPRICING 20
21 SEC LETTERS, FIRM DISCLOSURE & UNDERPRICING A one standard deviation increase in SEC uncertainty 4.2% more underpricing A one standard deviation increase in SEC weak/strong 5% more underpricing Confidential Filing 13.5% more underpricing A one standard deviation increase in factor1 8.7% less underpricing
22 SEC LETTERS, FIRM DISCLOSURES AND PIN 22
23 BENEFITS OF OPTIMAL DISCLOSURE OF SOFT INFO Underpricing generally increases under JOBS Act Disclosures changed Differences in soft info are related to underpricing Would underpricing have been larger had firms disclosures not changed? For each JOBS Act IPO: Calculate the difference in factor1 relative to matched peers Multiply this by the coefficient of factor1 in underpricing regression. Difference in Underpricing: 23
24 BENEFITS OF OPTIMAL DISCLOSURE OF SOFT INFO 24
25 LIQUIDITY 25
26 BENEFITS OF OPTIMAL DISCLOSURE OF SOFT INFO 26
27 CONCLUSION The JOBS Act relaxed constraints on disclosures of hard information IPO firms reduce disclosures of hard info and change disclosures of soft info SEC produces more information SEC soft info is more uncertain, negative in tone Differences in Soft (not Hard) info related to underpricing Differences in hard and soft related to PIN and Liquidity 27
28 HOW DO FIRMS DISCLOSURES CHANGE? 28
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