Law, Share Price Accuracy, and Economic Performance: The New Evidence

Abstract

The value of mandatory securities disclosure is intensely debated. Two big questions occupy much of the attention: Do more accurate share prices contribute to the efficient provision of goods and services in the economy? Even if they do, will mandatory disclosure effectively contribute to share price accuracy? To date, the debate has been largely theoretical. This Article sheds much needed empirical light on the matter. After introducing a new technique from financial economics-R 2-to measure share price accuracy, the Article starts by discussing recent R 2 studies by ourselves and others addressing the first question. Using both cross country and cross industry comparisons, the results show that more accurate share prices improve capital allocation and thus do in fact contribute to the efficient provision of goods and services in the economy. The Article then presents a new R 2 study that we have conducted addressing the second question. The study examines the effect of a December 1980 change in the SEC's disclosure rule requiring every issuer's filings to contain a section with management's discussion and analysis of the issuer's financial results (the "MD&A" rule). The change required managers to disclose any material information suggesting that the issuer's most recent results are not necessarily indicative of future results. Our study shows that share prices became more accurate a result of the changed rule, suggesting that mandatory disclosure can in fact be effective.

Information Markets and the Comovement of Asset Prices

“…The enactment of disclosure requirements in December 1980 created a natural experiment in which information became less costly and more abundant. Fox, Durnev, Morck and Yeung (2003) show that this legal reform caused a decline in comovement, just as predicted by the theory. At an international level, Li, Morck, Yang and Yeung (2004) argue there is more demand for production of information pertaining to countries with larger scope for foreign investment.…”

Private Information and Sunspots in Sequential Asset Markets

“…Legal reform on disclosure requirements for example can also produce more information for the uninformed investors. Fox, Durnew, Morck and Yeung (2003) show that the enactment of new disclosure requirements in December 1980 caused a decline in co-movements, consistent with our theory.…”

“…Proof. Both (12) and (13) are satis…ed. It is clear that with P 0 = P 1 = 1, investors in period 1 obtain no information about the dividend as the prices simply re ‡ect the unconditional expectation of the dividends in period 2.…”

“…Peck and Shell (1988) and Maskin and Tirole (1987). 13 Other recent papers in the literature have also explored the role of informational asymmetries and costly information to generate price movements that diverge from fundamentals in order to explain market data, without incorporating non-fundamentals into the information structures of markets that generate multiple rational expectations equilibria and sunspot ‡uctuations. Our results on the co-movement of asset prices in excess of the fundamentals are also related to those of Veldkamp (2006) who introduces multiple assets with correlated payo¤s and information markets into the model of Grossman and Stiglitz (1980).…”

The Use of the R2 as a Measure of Firm‐Specific Information: A Cross‐Country Critique

“…There is also a growing body of literature using the R 2 measure at the firm‐level (e.g., Durnev et al, 2001; Durnev et al, 2003; Fox et al, 2003; and Piotroski and Roulstone, 2004). Most of this literature uses the R 2 ‐methodology as proposed by Morck et al (2000) without questioning its reliability.…”