Effect of SEC's Proposed Short-Term Borrowing Disclosure Regulation on U.S. Stock Prices
Chamberlain, Trevor W., Sarkar, Sudipto, Khokhar, Rahman, International Advances in Economic Research
This study examines the market reaction to proposed short-term borrowing disclosure regulations and documents a positive market reaction, indicating the usefulness of the disclosure from the vantage point of investors.
The 2008 financial crisis, triggered in part by excessive bank borrowing, led to the failure of a number of major financial institutions, including one U.S. investment bank, Lehman Brothers. Investigating the reasons for Lehman's failure, the bankruptcy examiner determined in March 2010 that the bank had improperly moved $50 billion off its balance sheet by misclassifying short-term trades as sales. This, and similar window-dressing at other major banks, precipitated a Securities and Exchange Commission (SEC) inquiry. In April 2010, the SEC informed Congress that it was considering new rules to discourage financial firms from reducing borrowing in anticipation of their quarter-end reports.
Subsequently, in September 2010, the SEC unanimously voted for a proposed "Short-Term Borrowing Disclosure Rule" requiring additional quantitative and qualitative disclosure about short-term borrowing, with the primary objective of improving investors' understanding of reported amounts of short-term borrowing. The rule would apply to all SEC registrants, with most disclosure required of financial firms. In addition, the rule proposed a new financial firm definition to include many non-banking financial institutions. The regulation was posted for public comment for a period of sixty days, with a specific request for comments on the benefits to investors and costs to registrants.
The challenge facing the SEC was to identify the best cost-benefit trade-off in terms of the level of disclosure to be required. In order to inform this decision, the SEC invited public comment as a tool to evaluate the prospective effectiveness of the rule. However, this mechanism was limited in properly identifying the cost-benefit tradeoff for two reasons. First, the comments received were, with one exception, from SEC registrants or their representatives, and as such, did not necessarily represent the views of investors. Second, the responses were mixed, with some comments favouring enhanced disclosure and others expressing concern about the resulting cost.
This study attempts to obtain a broad assessment of investor opinion by investigating the market reaction to the SEC's announcement of its intention to consider stricter disclosure (the announcement date: April 21, 2010) and the reaction to the SEC's unanimous vote in favour of enhanced disclosure (the voting date: September 17, 2010). A positive (negative) market reaction to either event is interpreted as indicating that the benefits of the proposed rule exceed (fall short of) the costs.
Equally-weighted portfolios of 2,450 financial and 3,975 non-financial U.S. firms were used to compute mean cumulative abnormal stock returns for periods prior to, around, and after each of the announcement and voting dates. In general, the results show a positive (negative) reaction on the announcement (voting) date among financial firms' stockholders and a negative (positive) reaction on the announcement (voting) date among non-financial films' stockholders. …