Essays on information

My dissertation aims to explore mechanisms by which information about firms is produced and disseminated into the market and whether and how these mechanisms have asset pricing implications. The underlying question is the core of the discipline of financial economics: whether and how information matters for asset pricing. The dissertation contains two chapters. The first chapter, SEC Regulation Fair Disclosure, Information and the Cost of Capital, is an empirical investigation of the effects of the adoption of Regulation Fair Disclosure (“Reg FD”) by the U.S. Securities and Exchange Commission in October 2000. This rule was intended to stop the practice of “selective disclosure,” in which companies give material information only to a few analysts and institutional investors prior to disclosing it publicly. We find that the adoption of Reg FD caused a significant reallocation of information-producing resources, resulting in a welfare loss for small firms, which now face a higher cost of capital. The loss of the “selective disclosure” channel for information flows could not be compensated for via other information transmission channels. This effect was more pronounced for firms communicating complex information and, consistent with the investor recognition hypothesis, for those losing analyst coverage. Moreover, we find no significant relationship of the different responses with litigation risks and agency costs. Our results suggest that Reg FD had unintended consequences and that “information” in financial markets may be more complicated than current finance theory admits. The second chapter, Conflicts of Interest, Regulations and Stock Recommendations, examines how sell-side equity research companies (brokerage houses) responded to the increased scrutiny of their equity research business regarding conflicts of interest driven by investment bank relationships. This scrutiny materialized in new regulations adopted by the Self-Regulatory Organizations NASD and NYSE, affecting all brokerage houses, and in the Global Settlement, affecting the big 10 brokerage houses. The results suggest that the regulations achieved their goal of curbing effects of conflicts of interest in how recommendations are issued. While in the pre-regulatory period underwriter recommendations were more likely to be optimistic, and this bias was only partially recognized by the market, after the regulations were adopted the underwriter status is no longer a determinant of optimism in recommendations. I also report evidence of an overall change in the distribution of recommendations issued by brokerage houses after the new regulations took effect, in which they leaned towards less optimistic ratings. I provide evidence supporting the view that the change in the distribution of recommendations comes about due to a corrective process of renaming of ratings. I discuss the potential benefits of these changes, especially in view of empirical evidence (Malmendier and Shantikhumar, 2004) that retail investors used to take recommendations at face value in the period prior to the new regulations. The achievement of the new rules\u27 objective of a more meaningful use of ratings levels, together with the reduction of excess optimism linked to underwriting business, provides for a more leveled playing field between institutional and retail investors