Outcomes of Investing in OTC Stocks

U.S. Securities & Exchange Commission DERA White Paper, 2016

31 Pages Posted: 23 Dec 2016  

Joshua T. White

University of Georgia

Date Written: December 16, 2016

Abstract

This paper analyzes three aspects of over-the-counter (OTC) stocks: (1) the recent trends in the OTC stock market structure and size; (2) the documented properties of OTC stocks; and (3) the differences in returns based on investor and stock characteristics. Approximately 10,000 OTC stocks were quoted at the end of 2013 through 2015, generating a total trading volume of over $200 billion per year. Dollar volume has grown substantially since 2012 and is now concentrated in the segment of the OTC market with no requirements of registration or reporting to the U.S. Securities and Exchange Commission (SEC). A synthesis of recent academic literature reveals troubling properties of OTC stocks. Academic studies find that OTC stocks tend to be highly illiquid; are frequent targets of alleged market manipulation; generate negative and volatile investment returns on average; and rarely grow into a large company or transition to listing on a stock exchange. Moreover, these properties tend to worsen when the OTC company has fewer disclosure-related eligibility requirements. I examine the relationship between OTC investor demographics and investment outcomes using a proprietary database of transaction-level OTC data with confidential investor information. Analysis of 1.8 million trades by over 200,000 individual investors confirms that the typical OTC investment return is severely negative. Investor outcomes worsen for OTC stocks that experience a promotional campaign or have weaker disclosure-related eligibility requirements. Demographic analysis reveals that older, retired, low-income, and less educated investors experience significantly poorer outcomes in OTC stock markets. Given that retail investors are the predominant owners of OTC stocks, and the documented trend towards less transparent OTC companies, the results of this study have important implications for investor protection.

Keywords: Over-The-Counter, OTC, Microcap, Penny Stocks, Stock Promotions, Disclosure, Transparency, Behavioral Finance

JEL Classification: G00, G02, G11, G14, J11

Suggested Citation

White, Joshua T., Outcomes of Investing in OTC Stocks (December 16, 2016). U.S. Securities & Exchange Commission DERA White Paper, 2016. Available at SSRN: https://ssrn.com/abstract=2889360 or http://dx.doi.org/10.2139/ssrn.2889360

Joshua T. White (Contact Author)

University of Georgia ( email )

Terry College of Business
320 Sanford Hall, 312 Herty Drive
Athens, GA 30602-6253
United States
706-542-4450 (Phone)

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