Thursday, March 13, 2008

The Academic Research Surrounding Investor Relations and Disclosure

In preparation for my class on investor relations at Rice, I’ve been reviewing some of the academic research on the topic. It’s pretty tough sledding. Why can’t these guys learn to write in plain English? Here’s a direct quote from one of the articles I read: “Homogeneous precision of private information across investors ensures ex ante Pareto eļ¬ƒciency in the prior round of trade and the negative exponential utility function ensures concordant beliefs.” Write me if you think you can explain that to me. In the meantime I’ll omit the citation to avoid embarrassing the author.

In an effort to help explain why we engage in investor relations activities and voluntary disclosures beyond those mandated by regulations, I will attempt to summarize, in plain English, some of the research findings related to disclosure and investor relations.

Here are some of the key things I found:
1. Studies have found that improvements in the quality and quantity of voluntary disclosures improves a stock’s share price, trading volumes and narrows the bid – ask spread. The result of all this is increased liquidity and decreased volatility.
2. Sustained improvements in disclosure practices results in a lower cost of capital for the company as investors improve the rate at which they capitalize the firm’s earnings. This relationship held regardless of whether the firm actually posted improved earnings during the period.
3. The market reacts not only to the information contained in the disclosure announcements, but also to the flow of information itself. The reaction to the flow of information is the result of greater faith in management and its credibility, lowered estimates of the cost of information gathering and lowered risk assessments of the firm.
4. A firm’s lack of visibility, generally related to size, liquidity and exchange listing can hamper the effects of more disclosure. In other words, it does no good to disclose additional information if no one is paying attention. Smaller firms should engage in investor relations activities to raise their profile to complement their disclosure activities.
5. The effects of increased disclosure and investor relations activities take time. There is a lag period of about two quarterly reporting periods before the benefits to share price, increased liquidity and decreased volatility show up.

There’s more research out there, but frankly, I’ve had enough. There is a convincing case that increased investor relations activities and quality disclosures are good for a company’s share price over the long run. The question is, “Why do so many companies want to do as little investor relations as possible?” It’s a question for another day. Right now I’m going to go off and try and figure out the meaning of “ex ante Pareto efficiency”.