Externalities of public firm presence: Evidence from private firms' investment decisions

Abstract

Public firms provide a large amount of information through their disclosures. In addition, information intermediaries publicly analyze, discuss, and disseminate these disclosures. Thus, greater public firm presence in an industry should reduce uncertainty in that industry. Following the theoretical prediction of investment under uncertainty, we hypothesize and find that private firms are more responsive to their investment opportunities when they operate in industries with greater public firm presence. Further, we find that the effect of public firm presence is greater in industries with better information quality and in industries characterized by a greater degree of investment irreversibility. Our results suggest that public firms generate positive externalities by reducing industry uncertainty and facilitating more efficient private firm investment.JEL classifications: D80, D81, D92, G31, G32, G38, M41, M48. Keywords: Corporate investment, Uncertainty, Q theory, Private companies, Corporate disclosure, Financial accounting, Disclosure regulation.We thank Jed Neilson for valuable research assistance. We appreciate helpful comments from an anonymous

Is the risk of product market predation a cost of disclosure?

“…In this context, public firms can enrich the industry's information environment and thereby facilitate predation. Consistent with this, Badertscher et al (2013) present analogous evidence that the availability of public firm disclosures reduces industry uncertainty and thereby improves the responsiveness of other firms' investment decisions to potential investment opportunities.…”

“…I use total assets instead of sales because small and medium-sized private firms in Germany are not required to disclose sales. Ali et al (2009) show that incorporating private firm data is critical to proxy for market concentration, consistent with the importance of private firms to economic activity in the US and Europe (Badertscher et al, 2013;Minnis, 2011;Allee and Yohn, 2009). …”

“…constraint, consistent with the hypothesis that predation risk imposes additional costs of disclosure for relatively unprofitable firms with high levels of financial constraint. 30 Panel C shows that the effect of financial constraint on disclosure avoidance is stronger among firms that operate in industries that include at least one public firm, consistent with higher predation risk in industries with (1) at least one relatively sophisticated rival with easier access to external financing (Brav, 2009), and (2) lower investment uncertainty (Badertscher et al, 2013). Finally, Panel D shows that the positive relation between disclosure avoidance and financial constraint is significantly muted among firms that are more likely to rely on ex ante sales contracts.…”

“…A falsification test in the spirit of Badertscher et al (2013) suggests that the results do not extend to the UK, which did not implement an analogous enforcement change in 2006. Consistent with firms using disclosure decisions to mitigate competitive threats, I also find evidence that more financially constrained German private firms the private firms in my sample.…”

“…I proxy for the presence of a public rival using an indicator variable that equals one if there is at least one public German company in the firm's 4-digit NAICS code. This measure is intended to account for (1) the presence of competitors with fewer financing frictions than private firms (Brav, 2009), and (2) higher investment sensitivity in the industry (Badertscher et al, 2013). I include the measure of public firm presence as a main effect (as well as an interactive effect in the cross-sectional tests below) because greater investment sensitivity plausibly raises proprietary costs of disclosure across all firms.…”