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E-MailYan Xiong is an Assistant Professor of Finance at The Hong Kong University of Science and Technology, and Liyan Yang is a Professor of Finance at the Rotman School of Management, University of Toronto. This post is based on their paper forthcoming in The Review of Financial Studies. Related research from the Program on Corporate Governance includes The Law and Economics of Blockholder Disclosure (discussed on the Forum here) by Lucian Bebchuk and Robert J. Jackson Jr.; and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.
In February 2020, Castlefield, a U.K. investment company, publicly disclosed on its website a site visit it conducted with Alumasc, a U.K.-based supplier of premium building products. Site visits are considered costly and significant activities for investors to acquire information. Investors may have incentives to keep secret these activities to maintain their trading advantage over the market. Therefore, it raises the question of why an investor would voluntarily disclose the incidence of their site visits.
In fact, the mandatory disclosure of corporate site visits has been a subject of debate. The idea can be viewed as an extension of Regulation Fair Disclosure (Reg FD), which aims to prevent selective disclosure of material nonpublic information and ensure a level playing field for all investors. While the United States has not adopted a similar requirement, China has mandated the disclosure of site visits to enhance transparency.
In 2006, the Shenzhen Stock Exchange (SZSE) issued its own form of Reg FD, which prohibited SZSE-listed companies from selectively disclosing material nonpublic information to specific investors. Concurrently, the SZSE introduced a requirement for listed firms to disclose site visits in their annual reports. In 2012, the SZSE further mandated that all listed companies disclose site visits within two trading days through a dedicated web portal called Hu Dong Yi. What are the implications of regulations that enhance transparency regarding investors’ information acquisition practices?
Pricing Effects and Competition Effects
To answer these questions, we develop a theory that accommodates different degrees of investor information-acquisition observability. Our findings reveal two strategic effects on information acquisition resulting from improved observability. Firstly, the “pricing effect” emerges from interactions between those investors who demand liquidity by trading on information and those market participants who provide liquidity by making the market (the market maker), which can either encourage or discourage information acquisition. Secondly, the “competition effect” pertains to interactions among those investors trading on information and consistently promotes information acquisition.
Let’s first consider a monopoly economy with a single investor acquiring and trading on information, where only the pricing effect is at play. This pricing effect discourages information acquisition by an overt monopolistic investor compared to a secret monopolistic investor. Specifically, if an overt monopolistic investor enhances her information precision, the market maker recognizes her higher level of information and adjusts the pricing schedule and charge a higher bid-ask spread to mitigate adverse-selection risk. As a result, the investor’s profits decrease, reducing her incentives to acquire more information. Consequently, in equilibrium, an overt monopolistic investor acquires less information than a secret monopolistic investor.
The lower production of information leads to reduced efficiency in the overt market, as measured by the posterior precision of the fundamental conditional on asset prices. Additionally, due to the less pronounced adverse-selection problem faced by the market maker, the overt market exhibits higher market liquidity, indicated by the inverse of noise trading’s price impact.
In an oligopoly economy with multiple investors acquiring and trading on information, both the pricing effect and the competition effect come into play. The competition effect consistently encourages information acquisition among investors. When an investor overtly acquires information, it reduces the incentives for other investors to trade aggressively based on their private information. As the aggressive trading of others can harm the initial investor’s profits, the decrease in their trading aggressiveness provides an incentive for the initial investor to acquire information.
Unlike in the monopoly economy, the impact of the pricing effect in the oligopoly economy is ambiguous. The behavior of the pricing effect varies depending on the number of investors and the quality of their information. When there are only a few investors or their information quality is low, the pricing effect operates similarly to how it does in the monopoly economy. In this case, the pricing effect discourages information production under overt information acquisition.
Voluntary and Mandatory Disclosures of Corporate Site Visits
We then utilize our theory to examine the implications for investors’ corporate site visits, as initially discussed. According to the competition effect, an investor desires her rivals to perceive her information precision as being as high as possible to discourage these rivals from engaging in aggressive trading. Consequently, this effect motivates an investor to conduct a site visit and disclose the event to inform her rivals. This rationale helps to explain why certain investors, such as the U.K. investment company mentioned earlier, may choose to disclose their otherwise secretive site visits.
Furthermore, we make the prediction that investors are more inclined to make such disclosures when the number of investors trading the same asset is substantial and the cost of acquiring information is relatively low. These factors increase the importance of establishing a competitive edge through information acquisition, thus heightening the likelihood of disclosure.
In comparing the voluntary disclosure setting with the mandatory disclosure setting, our theory indicates that mandatory disclosure is effective when the pricing effect prevails. This is evidenced by the fact that investors would have voluntarily disclosed their site visits otherwise. The dominance of the pricing effect is contingent upon having a small number of investors or a high cost of acquiring information.
Furthermore, effective mandatory disclosure leads to investors acquiring less precise information. As a result, their payoffs increase, and market liquidity is enhanced. However, this comes at the expense of reduced market efficiency. Interestingly, recent studies have indeed found that the introduction of the SZSE’s mandatory, near-real-time disclosure of site visits has resulted in a decrease in the informational efficiency of SZSE-listed firms.
In a broader sense, Regulation Fair Disclosure (Reg FD) effectively enhances the observability of investors’ information-acquisition activities. While it does not outright prohibit private meetings, it imposes disclosure requirements on such communications. Specifically, Reg FD mandates that when a company holds private meetings with select investors, it must disclose the occurrence of these events to the public.
By enforcing these disclosure requirements, Reg FD allows the market to gain insights into which investors are participating in these forthcoming meetings based on the company’s disclosures. As firms often value their relationships with large investors and frequently engage in private meetings with them, this disclosure mechanism provides the market with valuable information.
Our analysis suggests that the implementation of Reg FD leads to a decrease in information production and market efficiency but an increase in market liquidity. These effects are particularly pronounced for firms with a small number of investors or when the cost of acquiring information relative to noise trading is high.
