Corporate opacity benefits – SURPRISE! – the institutional investor
The U.S. House of Representatives passed the Entrepreneur Access to Capital Act (EACA) in November 2011, allowing firms to raise up to $2 million in investments of less than $10,000 per investor without significant regulatory oversight. Critics of the bill raised concerns about the potential for fraud in the absence of centralized regulation.
The U.S. debate about the optimal level of regulation of financial markets is broadly applicable to other markets where similar debates are taking place, and new research by Mark Maffett (Ph.D. '12) delineates some of the potential implications of reducing financial reporting regulations.
Firms in opaque information environments, such as in emerging markets, experience more informed trading by institutional investors – and those investors can realize significant returns as a result, potentially at the expense of the less sophisticated investor.
Maffett contributes to the debate in his dissertation “Who Benefits from Corporate Opacity? International Evidence From Informed Trading by Institutional Investors.”
“Country-level infrastructure affects the availability of financial reporting information,” Maffett said. “Disclosure requirements, corporate governance requirements, even the development of the news media, affect the availability of financial reporting information. In emerging markets, you’d expect those aspects to be less developed, and that’s going to lead to more informed trading that leaves less sophisticated investors – the kind
EACA is intended to attract – vulnerable.”
Those aspects hold policy implications: A country can make infrastructure improvements to mitigate opacity. From a business perspective, more informed trading can have capital market implications, such as reduced stock market liquidity, higher cost of capital or lower firm valuation, in part because less informed investors will limit what they’re willing to pay for the firm’s shares, knowing they likely are trading against a more informed party.
“The debate about the EACA opens the question of the optimal level of financial reporting regulation,” Maffett said. “My research sheds light on the potential costs and benefits of varying levels of regulation at the firm and country levels.”
Mark Maffett earned his Ph.D. in accounting at UNC Kenan-Flagler. He is now an accounting professor at the University of Chicago.