The Twilight Zone: OTC Regulatory Regimes and Market Quality

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Leibniz Institute SAFE; CESifo Research Network; Center for Financial Studies (CFS)

Ingrid M. Werner

The Ohio State University - Fisher College of Business

There are 3 versions of this paper

Date Written: June 14, 2017

Abstract

We analyze a comprehensive sample of more than 10,000 U.S. OTC stocks. We first show that the OTC market is a large, diverse, and dynamic trading environment with a rich set of regulatory and disclosure regimes, comprising venue rules and state laws beyond SEC regulation. We then exploit this institutional richness to analyze two key dimensions of market quality, liquidity and crash risk, across firms and regulatory regimes. We find that OTC firms that are subject to stricter regulatory regimes and disclosure requirements have higher market quality (higher liquidity and lower crash risk). Our analysis points to an important trade-off in regulating the OTC market and protecting investors: Lowering regulatory requirements (e.g., for disclosure) reduces the compliance burden for smaller firms, but it also reduces market quality.

Keywords: Securities Regulation, Disclosure, Liquidity, Crash Risk, Blue Sky Laws, Pink Sheets, Bulletin Board, JOBS Act

JEL Classification: G14, G15, G30, K22, M41, M48

Suggested Citation: Suggested Citation

Brüggemann, Ulf and Kaul, Aditya and Leuz, Christian and Werner, Ingrid M., The Twilight Zone: OTC Regulatory Regimes and Market Quality (June 14, 2017). IGM Working Paper #95, Fisher College of Business Working Paper No. 2013-03-09, European Corporate Governance Institute (ECGI) - Law Working Paper No. 224/2013, Charles A. Dice Center Working Paper No. 2013-09, Available at SSRN: https://ssrn.com/abstract=2290492 or http://dx.doi.org/10.2139/ssrn.2290492