Regulation Fair Disclosure and the Cost of Adverse Selection

Journal of Accounting Research, Vol. 46, Issue 3, pp. 697–728, June 2008

40 Pages Posted: 20 Jul 2006 Last revised: 28 Nov 2012

See all articles by Baljit K. Sidhu

Baljit K. Sidhu

UNSW Australia Business School, School of Accounting

Tom Smith

University of Queensland - Faculty of Business, Economics and Law; Financial Research Network (FIRN)

Robert E. Whaley

Vanderbilt University - Finance

Richard H. Willis

Vanderbilt University - Accounting

Date Written: August 20, 2007

Abstract

Regulation Fair Disclosure (FD), imposed by the Securities and Exchange Commission in October 2000, was designed to prohibit disclosure of material private information to selected market participants. The informational advantage such select participants gain is unclear. If multiple “insiders” receive identical information, private information is immediately incorporated in price and each insider has zero expected profit. If, on the other hand, Regulation FD has curtailed the flow of information from firms, private information becomes longer-lived and more valuable. Hence, market makers will demand increased compensation by widening the adverse selection component of the bid-ask spread. We identify the cost components of the bid-ask spread for a sample of NASDAQ stocks surrounding the implementation of Regulation FD. Controlling for other factors affecting the spread, we find that adverse selection costs increase approximately 36% after Regulation FD. We interpret our finding as Regulation FD failing to achieve one of its desired objectives.

Keywords: adverse selection, Reg FD, bid/ask spread, private information

JEL Classification: D23, D82, G12, G13, G14, G38, L22

Suggested Citation

Sidhu, Baljit K. and Smith, Tom M. and Whaley, Robert E. and Willis, Richard H., Regulation Fair Disclosure and the Cost of Adverse Selection (August 20, 2007). Journal of Accounting Research, Vol. 46, Issue 3, pp. 697–728, June 2008, Available at SSRN: https://ssrn.com/abstract=917850

Baljit K. Sidhu

UNSW Australia Business School, School of Accounting ( email )

Sydney, NSW 2052
Australia

Tom M. Smith

University of Queensland - Faculty of Business, Economics and Law ( email )

4072 Brisbane, Queensland
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Robert E. Whaley (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
615-343-7747 (Phone)
615-376-8879 (Fax)

Richard H. Willis

Vanderbilt University - Accounting ( email )

Nashville, TN 37203
United States
615-343-1050 (Phone)
615-343-7177 (Fax)

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