Externalities of Disclosure Regulation: The Case of Regulation FD

Abstract

We use Regulation Fair Disclosure (REG FD) to examine a relatively neglected but important effect of disclosure regulation: externalities. REG FD applies to all publicly traded U.S. firms, but foreign firms cross-listed on U.S. stock exchanges are explicitly exempt. Despite the exemption, we find that many cross-listed firms voluntarily adopt REG FD as part of their disclosure policies. We hypothesize that REG FD imposes two externalities on cross-listed firms. First, following REG FD, previously disadvantaged U.S. investors have a lower demand for shares of cross-listed firms that continue to follow a selective disclosure policy. Second, REG FD creates an information spillover effect on cross-listed firms whose receipt of information is positively correlated with that of U.S. firms. We find evidence of both effects in cross-listed firms’ voluntary REG FD adoption decisions. Relative to non-adopters, cross-listed firms who voluntarily adopt REG FD exhibit a significant reduction in the information asymmetry component of cost of capital and are also more likely to switch to open disclosure post REG FD. These results suggest that cross-listed firms’ voluntary REG FD adoption represents a credible commitment to increased disclosure transparency.

Keywords: Regulation Fair Disclosure, disclosure externalities, cross-listed firms

JEL Classification: G, K2, M4, N2