Blinded by the Light: Information Overload and its Consequences for Securities Regulation

Abstract

A demanding system of mandatory disclosure, which has become more demanding in the wake of the Sarbanes-Oxley Act of 2002, makes up the core of the federal securities laws. Securities regulation is motivated, in large part, by the assumption that more information is better than less. After all, "sunlight is said to be the best of disinfectants; electric light the most efficient policeman." But sunlight can also be blinding. Two things are needed for a regulatory regime based on disclosure, such as the federal securities laws, to be effective. First, information has to be disclosed. Second, and often overlooked, is that the users of the information - for example, investors, securities analysts, brokers, and portfolio managers - need to use the disclosed information effectively. Securities regulation focuses primarily on disclosing information, and pays relatively little attention to how the information is used - namely, how do investors and securities market professionals search and process information and make decisions based on the information the securities laws make available? Studies making up the field of behavioral finance show that investing decisions can be influenced by various cognitive biases on the part of investors, analysts, and others. This Article focuses on a related concern: information overload. An extensive psychology literature shows that people can become overloaded with information and make worse decisions with more information. In particular, studies show that when faced with complicated tasks, such as those involving lots of information, people tend to adopt simplifying decision strategies that require less cognitive effort but that are less accurate than more complex decision strategies. The basic intuition of information overload is that people might make better decisions by bringing a more complex decision strategy to bear on less information than by bringing a simpler decision strategy to bear on more information. To the extent that investors, analysts, and other capital market participants are subject to information overload, the model of mandatory disclosure that says more is better than less may be counterproductive. This Article considers the phenomenon of information overload and its implications for securities regulation, including the possibility of scaling back the mandatory disclosure system.

Keywords: information overload, securities regulation, Sarbanes-Oxley, mandatory disclosure, corporate governance, efficient capital market hypothesis, behavioral finance, behavioral law and economics, cognitive psychology, bounded rationality