By Greenstone, Michael; Oyer, Paul; Vissing-Jorgensen, Annette
Regulation , Vol. 29, No. 2
Since the passage of the Securities Act of 1933 and the Securities Exchange Act of 1934, the federal government has actively regulated U.S. equity markets. The centerpiece of those efforts is the mandated disclosure of financial information.
Previous research provides mixed evidence on the impact of mandatory disclosure. Theoretical models suggest that those laws can be beneficial when the costs of writing or enforcing private contracts that bind managers to maximize shareholder value are sufficiently high. Although the first empirical evaluations of mandatory disclosure laws were published four decades ago, the extensive subsequent literature has failed to reach a consensus. The absence of convincing evidence has led some legal scholars to recommend significant modification or repeal of the statutes that regulate U.S. securities markets, including the mandatory disclosure requirements.
This article presents new evidence on the impacts of mandatory disclosure laws by analyzing the effect of the 1964 Securities Acts Amendments on stock returns and operating performance of firms newly affected by this legislation. With the exception of the Sarbanes-Oxley Act of 2002, the 1964 Amendments are the last major mandatory disclosure regulations applied to U.S. equity markets. They extended the disclosure requirements that have applied to firms traded on exchanges, such as the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX), since 1934 to firms traded "over-the-counter" (OTC) that exceeded asset and shareholder floors.
Specifically, covered OTC firms were required to: (1) register with the Securities and Exchange Commission; (2) provide regular updates on their financial position, such as audited balance sheets and income statements; (3) issue detailed proxy statements to shareholders; and (4) report on insider holdings and trades. Some OTC firms were already fulfilling requirements (1) and (2) and only had to begin complying with (3) and (4), while others had to begin complying with all four provisions.
We compare the stock returns and operating performance of affected OTC firms with NYSE and AMEX firms. We also contrast those outcomes among OTC firms that are differentially affected by the 1964 Amendments. We consider the period between January 1, 1963 and November 15, 1965 (Period 1), when the amendments were proposed and passed into legislation and firms registered with the SEC, and the period from November 15, 1965 to the end of 1966 (Period 2), when no new information about the law was revealed.
During Period 1, OTC firms that were newly required to begin complying with all four forms of mandatory disclosure had statistically significant positive abnormal excess returns ranging between 11.5 and 22.1 percent, relative to matched NYSE and AMEX firms. The estimates imply that the 1964 Amendments created $3.2 to $6.2 billion (in 2005 dollars) of value for shareholders of the OTC firms in our sample.
Overall, the results suggest that the benefits of the 1964 Amendments as measured by stock returns substantially outweighed the cost of complying with the law. This implies that the affected firms were not managed to maximize shareholder value prior to 1964. We cannot determine whether this was because managers made negative net present value "empire building" acquisitions, lavished excessive salaries or perks on themselves, engaged in insider trading that reduced the liquidity of the firm's shares, or some other mechanism. Regardless of the exact channel, our findings are consistent with the notion that mandatory disclosure laws can cause managers to focus on improving shareholder value. This finding is a necessary condition for a positive welfare effect, but it is not sufficient because we cannot rule out the possibility that managers lost an amount equal to that gained by shareholders.
For decades, some economists (led by the late Nobel Prize winner George Stigler) have argued that additional legislation in the securities market is not nearly as efficient as private contracts combined with the possibility of litigation. …