Optimal Disclosure and Litigation Rules Around IPOs and SEOs
61 Pages Posted: 28 Nov 2017 Last revised: 6 May 2018
Date Written: April 25, 2018
We develop a model to analyze the optimality of allowing firms to disclose various kinds of information prior to initial public offerings (IPOs) and seasoned equity offerings (SEOs), and of alternative rules to govern private securities litigation. In our model, firm insiders, with private information about variables affecting their future firm performance, may make disclosures (claims) about their future realization prior to selling new equity to outsiders. The issue price of firms' equity is affected by their disclosures; by the demand for equity from institutional investors, who may conduct costly (and noisy) verifications of firm disclosures; and by the demand from retail investors, who do not have access to such an informative verification technology. There may also exist an agency with the power to regulate firm disclosures; and private securities litigation, as a result of which the courts are able to penalize firms ex post for making optimistic disclosures without a strong basis in fact. We develop several new results in the above setting. First, even in the absence of an agency regulating firm disclosures, equity issuing firms have incentives to self-regulate in some situations, resulting in more conservative disclosures. Second, whether allowing an item of disclosure prior to an equity issue is desirable or not depends upon the proportion of institutional investors in the equity market, their cost of verifying that disclosure item, the informativeness of their verification technology, and the participation rate of retail investors in the equity issue. Third, whether relaxing rules for bringing private securities lawsuits against firms falling short on disclosed variables encourages or discourages firm disclosures prior to an equity issue depends on whether the litigation regime is more or less sensitive to firm insiders' private information at the time of disclosure.
Keywords: Disclosure rules, initial public offerings (IPOs), seasoned equity offerings (SEOs), private securities litigation
JEL Classification: G24, G28, G32, G38
Suggested Citation: Suggested Citation