Measuring Securities Market Efficiency in the Regulatory Setting

Abstract

In the "Aircraft Carrier," the Securities and Exchange Commission (SEC) proposed changes in federal securities disclosure requirements in an attempt to enhance and facilitate the process of issuing new securities. Under the proposed regulatory regime, the registration process would be simplified so that many larger, more experienced issuers would be able to use a new, shorter registration statement called Form B (as opposed to the more extensive Form A) whenever they sell securities to the public. To qualify to use Form B, a company with at least twelve months reporting history under the Exchange Act must either have a public float of $75 million or more and an average daily trading volume (ADTV) of $1 million or more, or have a public float of $250 million or more.

In this paper, we argue that the SEC's study of capital market efficiency employs too broad a definition of what constitutes "an analyst" who represents an important conduit for information between a company and its investors. We adjust the definition of an analyst to more accurately reflect only those analysts whose research effectively disseminates information to investors in the market (sell-side analysts) and find that the proposed numerical cutoffs for the use of Form B are set much too low to insure adequate analyst following. This finding is consistent with evidence we present that a substantial percentage of companies eligible to use Form B have low levels of institutional investor shareholdings.

Based on a sample of companies whose stock price was greater than $1.00 on 12/31/99, we find that 3,413 (43.3%) of firms in the sample qualify to file Form B using the SEC's proposed numerical cutoffs. Using First Call's consensus earnings estimate service, we examine the analyst following of firms that have a market capitalization greater than $250 million and find that 26.1% of these firms have less than three analysts compared to the 5.0% reported by the SEC. We also examine the SEC's second criteria (market capitalization greater than $75 million and average daily trading volume (ADTV) of $1 million) and find that 38.1% of companies have less than three analysts compared to the 14.0% reported by the SEC. We argue that equity or sell-side analyst following represents an important source of information to investors and should be considered when establishing criteria for relaxed reporting requirements when companies issue securities.