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
GAME CHANGER
2
THEME
How does the Jumpstart Our Business Startups
(JOBS) Act affect disclosures of hard and soft
information and IPO outcomes?
3
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
Information
• Market responds
Firms should also change disclosures of soft
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
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
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)
DATA (2010 – 2013)
•
•
•
•
•
•
8
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?
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 1st 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
BACKGROUND
10
HOW DO FIRMS’ DISCLOSURES CHANGE?
11
RISK FACTOR EXAMPLES
12
DISCLOSED RISK FACTORS
Low tech
vs
High tech
13
(Non-bio)
high tech
vs
Bio-tech
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
HOW DO FIRMS’ DISCLOSURES CHANGE?
CORRELATIONS
15
SEC COMMENT LETTER TO QUALYS, INC
SEC COMMENT LETTER TO QUALYS, INC
HOW DO SEC COMMENT LETTERS CHANGE?
18
HOW DO INVESTORS REACT? UNDERPRICING
19
HOW DO INVESTORS REACT? UNDERPRICING
20
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
SEC LETTERS, FIRM DISCLOSURES AND PIN
22
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
BENEFITS OF OPTIMAL DISCLOSURE OF SOFT INFO
24
LIQUIDITY
25
BENEFITS OF OPTIMAL DISCLOSURE OF SOFT INFO
26
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
HOW DO FIRMS’ DISCLOSURES CHANGE?
28