Abstract
In this paper, we examine whether a regulatory shift allowing more private firm disclosure leads to less myopia. The Jumpstart Our Business Startups (JOBS) Act of 2012 permits a subset of firms to meet privately with potential investors in the months before an IPO, allowing them to provide information without proprietary cost concerns, leading to more complete disclosure. Consistent with a reduction in myopia, we find that these firms are less likely to manage earnings to beat short-term benchmarks, are punished less harshly by the market (via stock price declines) when they do miss the earnings benchmark, and provide fewer short-horizon forecasts. We also find that firm disclosures are less short-term focused, investors have longer holding periods than do those same investors in non-JOBS Act IPO firms and that these firms attract more long-term investors. Our results hold (i) across the subsample of firms for which other JOBS Act provisions were already present, and (ii) after controlling for those other provisions, consistent with private discussions acting as the primary mechanism. Our results are also strongest for firms with higher proprietary costs, consistent with private disclosure reducing myopia by reducing proprietary cost concerns. Collectively, this evidence suggests that when firms are able to privately disclose information to investors, both firms and investors become less myopic.
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Notes
As Stein (1988) indicates, “Relatively patient stockholders may not be discouraged by a low earnings report; they may attribute it to a policy of long-term investment by the firm... Impatient shareholders, on the other hand, may become very distressed by low earnings reports and may try to dump a stock as soon as such a report is issued. If such impatience is widespread, managers will be more fearful of undervaluation…Hence efforts to boost current earnings will be more intense.” We argue that investors become more ‘patient’ when they better understand the firm’s prospects, thereby allowing managers to focus on long-term results.
Although managers of public firms are also allowed to meet privately with analysts and investors under Reg-FD, they are not allowed to provide any material nonpublic information. Instead, managers can only help market participants assimilate information by clarifying details within public disclosures, correcting investor misinformation, and summarizing and/or tying together public disclosures (Chapman et al. 2018). That is, Reg FD prohibits selective disclosure,’ but allows ‘selective access’ to management. Note too that the SEC did not believe Reg FD was necessary for pre-IPO discussions. As noted in Section 6 of their final rule, “We are satisfied that the Securities Act already accomplishes at least some of the policy imperative of Regulation FD within the context of a registered offering.” (SEC 2000). As such, the SEC made a Reg FD exemption for pre-IPO discussions.
Our discussions with several managers of JOBS Act IPO firms confirmed that TTW meetings commonly address many more details regarding proprietary (competitively sensitive) information, such as the technical or scientific aspects of their products, than are shared in other venues throughout the IPO process or after a firm becomes public.
As one anonymous manager told us, “A core group of TTW investors has stuck with the company over several years since the IPO. … They are the least reactive to bad news or bumps along the way and are better able to keep a long-term perspective. They know the story inside and out and are the least likely to call me right after an earnings announcement in panic over some small detail.”
The IPO underwriting agreement frequently indicates only whether a firm authorized the underwriter to set up TTW meetings (and not whether such meetings actually occurred). However, anecdotal evidence and our conversations with managers of firms that went public under the JOBS Act indicate that very few R&D-intensive firms did not test-the-waters because the costs of doing so are low and the benefits are potentially large.
Note, however, there are exceptions to Reg FD’s mandate. For example, some parties, such as auditors, consultants, analysts, business partners, credit rating agencies and investors with bilateral contracts (Schoenfeld 2020; Nagar and Schoenfeld 2020) can have access to private information. However, Reg FD requires either (i) the firm to publicly disclose the private information, or (ii) these parties not to trade on the information. In contrast, in the TTW setting, the expectation is that the investors will trade on the information.
Within the disclosure literature, we also contribute to the selective access literature, which examines selective access in the context of invite-only investor and analyst conferences (e.g., Bushee et al. 2017; Green et al. 2014a, 2014b) as well as firm meetings with investors and analysts (Bushee et al. 2018; Solomon and Soltes 2015). The results from these studies suggest that selective access provides informational benefits to investors and analysts. We contribute to this literature by showing that private disclosure can provide benefits to the firm by mitigating myopia. We note, however, that these benefits would not accrue to public firms that meet privately with market participants, as they are currently subject to Reg FD.
Dambra and Gustafson (2021) indicate that firms that IPO under the JOBS Act invest more in capital and R&D expenditures, and do so more efficiently than firms that IPO in the pre-JOBS Act regime.
We note, however, that although there is some potential for adverse selection concerns from those investors not engaged in TTW talks, our discussions with several managers of JOBS Act IPO firms indicate that most (roughly 75%–80%) of the investors involved in TTW discussions continue to hold shares for years after the IPO, and that these investors have close relationships with management and a long-term focus. So, any adverse selection concerns related to these investors are perhaps not fully warranted.
Appendix 2 provides further detail on the non-TTW provisions of the JOBS Act.
One might believe that managers would be unwilling to provide valuable information in TTW meetings, as it could risk potential leakage into the market. However, this potential is mitigated by two factors. First, TTW meetings often involve a series of discussions, where initial rounds serve to screen investors for interest and fit. Relatively more proprietary information can then be withheld until subsequent rounds after mutual interest and a relationship has been established. Second, reputation concerns discipline investors from sharing proprietary information received in TTW talks. As one JOBS Act IPO manager mentioned, “We aren’t worried too much about the possibility of investors sharing our private information, because they know it would have serious consequences for their reputation in future dealings with IPO firms.”
Our results are not inconsistent with higher uncertainty among some investors after the JOBS Act because only certain investors participate in TTW meetings. Thus, uncertainty may increase for those not participating (i.e. retail investors and some institutional investors) as they are concerned about potentially trading with investors involved in TTW talks (i.e., more informed traders).
We exclude 33 IPOs that had a prospectus filing date before and an IPO issue date after, the enactment of the JOBS Act.
See Rubin and Thomas (2000), Abadie and Imbens (2006), and Kirk and Vincent (2014). Our reported results include some first-stage covariates in the second-stage regressions where appropriate given the design of each second-stage regression, as described in Section 4. In untabulated analysis, we include all first-stage covariates in the second-stage regressions and find results that are similar.
Available at: http://acct.wharton.upenn.edu/faculty/bushee/IIclass.html.
We focus our analysis of earnings management on tests of the final impact of earnings management rather than on specific methods because we do not expect managers, on average, to use all forms of earnings management in every setting and we lack a strong prediction on which methods firms will use given their unique circumstances. In Table 13, we find results consistent with our inferences using specific methods of earnings management frequently used in prior literature. Specifically, we find JOBS Act firms are less likely to cut R&D expenses, SG&A expenses, or capital expenditures to meet an earnings benchmark.
In untabulated analyses, we find that our results are not sensitive to using two cents or three cents instead of a one cent range.
These industries include mining (SIC codes: 10–14), wholesale trade (SIC codes: 50–51), retail trade (SIC codes: 52–59) and manufacturing (SIC codes: 20–39) except manufacturing industries with more specialty products, i.e., chemicals and allied products (SIC code: 28), industrial and commercial machinery and computer equipment (SIC code: 35), electronic and other electrical equipment and components (SIC code: 36), and measuring, analyzing, and controlling instruments (SIC code: 38).
We acknowledge that non-earnings metrics may be more salient for some firms immediately after the IPO; unfortunately, such metrics are often firm-specific (e.g., key milestones in regulatory approval for a biotech firm) and therefore difficult to identify across our sample. Additionally, while earnings and beating expectations may not be the most important factors, they do seem to remain relevant signals for investors (as indicated by the significant main effect for missing analysts’ earnings benchmarks in Table 5). We simply examine the relative difference in market reactions to missed benchmarks between the treatment and control firms.
One potential reason for the lack of a result for this test is low power. That is, while we are confident that TTW meetings are ubiquitous in R&D-intensive industries, we do not know how common they are in non-R&D-intensive industries. For the comparison effect in this test, we would like a sample of firms that do not use TTW; however, the non-R&D industries likely vary in how much they use TTW. So, while we label these firms “low proprietary,” many may still benefit from TTW in the same way as the R&D-intensive firms. To the extent the prevalence and effect are similar across treatment and controls firms, this reduces the power of the test.
Economic magnitudes are calculated using the sample means for Short Horizon of 1.882 and 1.803 for the primary sample and PSM matched sample, respectively.
For example, Dambra et al. (2015) indicate adoption rates for the delayed adoption of new standards and exemption of PCAOB rules were 13.5% and 17.9%, respectively.
We assume that firms not subject to SOX 404(b) internal controls audits do not voluntarily undertake them. We believe this is a reasonable assumption given that these audits are costly, particularly for small firms (Iliev 2010). In fact, Engel et al. (2007) suggest that at least some firms took the extreme measure of going private partly to avoid these costs.
We perform this analysis on the primary sample because control firms in the PSM sample are arguably less comparable, given historical changes regarding which firms qualified for SOX 404(b) exemptions and scaled disclosure. For example, prior to 2008, scaled disclosure was only afforded to firms with less than $25 million of public float (the threshold was increased to $75 million in 2008). Additionally, prior to 2010, firms with less than $75 million of public float were allowed a temporary delay (rather than a permanent exemption) from SOX 404(b) compliance. These factors reduce comparability in the post-JOBS Act period, when the PSM sample is constructed, and for several years after their IPOs (when exemptions and size categories might vary). Given that the primary sample is unaffected by these factors (because control firms have IPO dates starting in 2010), we use the primary sample for this analysis.
Given the fact that approximately 99% of eligible firms in our sample utilize the provision allowing for reduced executive compensation disclosure, we omit this provision because it is almost perfectly collinear with PostJOBS. We rely on the SRC test to control for this provision by showing the results hold when this provision applied before the JOBS Act.
We use the primary sample for this analysis to be consistent with the SRC analysis. However, in untabulated results, we find that our inferences using the PSM matched sample are qualitatively similar.
We obtain data on bankruptcies and de-listings from 8-K filings on EDGAR. We limit this analysis to the primary sample since we measure the prevalence of negative outcomes within the first three years after the IPO. Our control group in the PSM matched sample includes observations past the first three years after going public.
We modify the approach in Bushee (1998) by using analyst forecasts instead of the prior year’s earnings as the earnings benchmark because analyst forecasts more directly reflect investors’ expectations. We also use the lagged value of the discretionary expenditure instead of the prior change in the discretionary expenditure (which requires only one year of prior data instead of two). To further increase the sample size, we do not limit the sample to firms with at least four other firms in the same SIC code. Lastly, we estimate Equation (1) at the firm-quarter level rather than the firm-year level. We also exclude stale forecasts (those more than 90 days old).
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Acknowledgements
We are very grateful to Rick Laux for many thoughtful discussions during the initial stages of this project. We would also like to thank Mike Minnis, Nemit Shroff, Dan Taylor, Jake Thornock, an anonymous referee, and workshop participants at Dartmouth College, Penn State University, the University of Notre Dame, and Washington University in St. Louis for helpful comments and suggestions. We also thank six anonymous managers for helpful discussions of their experiences with IPOs both before and after the adoption of the JOBS Act.
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Appendices
Appendix 1 Variable Definitions
Variable | Definition |
|---|---|
Analysts | The number of analysts providing earnings estimates during the quarter |
Bankruptcy/Delisting | Indicator variable equal to 1 if the firm went bankrupt or delisted within the first three years after going public, or 0 otherwise |
Capex t-1 | Capital expenditures in the prior year |
Capex Cut | Indicator variable equal to 1 if the change in capital expenditures relative to the same quarter in the prior year is negative, or 0 otherwise |
CAR[-1,1] | The three-day cumulative abnormal return centered on the earnings announcement date |
Cash | Total cash holdings scaled by total assets |
Cash flows | Operating cash flows scaled by total assets |
Ch_Capex | Change in the log of capital expenditures scaled by shares outstanding |
Ch_GDP | Change in GDP, collected from the Bureau of Economic Analysis |
Ch_Ind R&D | Change in the log of the sum of industry R&D divided by the sum of industry sales |
Ch_Sales | Change in the log of sales revenues scaled by shares outstanding |
Disclosure | Indicator variable equal to 1 if the firm provided two years of audited financial statements, or 0 otherwise |
Dispersion | The standard deviation of analysts’ earnings forecasts, scaled by stock price |
Distance | The mean analyst forecast (after adding back prior-period R&D expense) minus the actual earnings after adding back current-period R&D expense, scaled by prior period R&D |
Dividend Yield | Dividends per share scaled by stock price 30 days prior to the earnings announcement |
Dodd Frank | Indicator variable equal to 1 if the firm opted out of shareholder advisory votes required by Dodd Frank, or 0 otherwise |
Forecasts_Total | The number of forecasts issued by the firm during the quarter. The variable is set to 0 if the firm does not issue forecasts |
Forecast error | The actual earnings minus the mean analyst forecast, scaled by stock price 10 days prior to the earnings announcement |
Free cash flow | Earnings before extraordinary items plus depreciation expense minus the change in current assets plus the change in current liabilities plus the change in cash minus the change in current debt minus lagged capex, scaled by lagged current assets |
GAAP | Indicator variable equal to 1 if the firm took advantage of an extended phase-in for accounting standards issued by FASB, or 0 otherwise |
High | Indicator variable equal to 1 for firms in industries with high levels of proprietary information and 0 for firms in industries with low levels of proprietary information. |
Holdings | Log of the market value of the investor’s position in a firm |
Institutional Ownership | Percentage of shares owned by institutional investors collected from the Thomson Reuters 13F database |
Investor Size | Log of the total market value of the investor’s portfolio |
Leverage | The sum of long-term and current debt, scaled by total assets |
Liquidity | Current assets divided by current liabilities |
Loss | Indicator variable equal to 1 if actual earnings reported in IBES is negative and 0 otherwise |
Meet or beat | Indicator variable equal to 1 if the difference between actual earnings and the mean analyst forecast is between 0 or 1 cent (inclusive), or 0 otherwise |
Miss | Indicator variable equal to 1 if the firm’s actual earnings are less than the mean analyst forecast, or 0 otherwise |
MTB | Market value of equity divided by book value of equity |
Net Purchases | Signed change in the market value of the investment position in quarter t (after adjusting for the change in price) divided by the average of the market value of the position over quarters t and t-1. |
Operating Cycle | Log of (Inventory/COGS)*360 + (Accounts Receivable/Sales)*360 |
PCAOB | Indicator variable equal to 1 if the firm chose to opt out of complying with future PCAOB rules, or 0 otherwise |
PostJOBS | Indicator variable equal to 1 if the firm went public between April 5, 2012, and December 31, 2014, or zero otherwise |
Price | Log of the average daily price during the three months before the earnings announcement |
P/E | Stock price 30 days prior to the earnings announcement divided by earnings per share |
Reporting Lag | Number of days between the fiscal period end date and the earnings announcement date |
Returns[0,90] | The cumulative return over the three months after the earnings announcement |
ROA | Earnings before extraordinary items divided by total assets |
ROE | Earnings before extraordinary items divided by book value of equity |
R&D t-1 | Research and development expense in the prior year |
R&D Cut | Indicator variable equal to 1 if the change in R&D expense relative to the same quarter in the prior year is negative, or 0 otherwise |
Sales | Log of sales revenues |
SalesGrowth | The percentage change in sales revenues over the quarter |
SG&A t-1 | Selling, general and administrative expense in the prior year |
SG&A Cut | Indicator variable equal to 1 if the change in SG&A expense relative to the same quarter in the prior year is negative, or 0 otherwise |
Short Horizon | The ratio of short-term to long-term words in the 10-K or 10-Q filed during the quarter using the list of short and long-term words developed by Brochet et al. (2015) |
Size | Log of market value of equity |
SOX | Indicator variable equal to 1 if the firm elected to opt out of auditor attestation required by Section 404(b) of Sarbanes-Oxley, or 0 otherwise |
Spread | The average daily bid-ask spread (calculated as bid-ask/bid+ask/2) over the three months prior to the earnings announcement |
ST_Forecasts | The number of short-term forecasts, defined as forecasts with a horizon of up to one year, issued by the firm during the quarter. The variable is set to 0 if the firm does not issue forecasts |
Tangibility | Calculated following Berger et al. (1996): (0.715*Receivables + 0.547*Inventory + 0.535*PPE + cash), scaled by total assets |
Turnover | The average of daily trading volume divided by shares outstanding over the three months prior to the earnings announcement |
Volatility | The standard deviation of daily returns over the three months prior to the earnings announcement |
VC Backed | Indicator variable equal to 1 if the firm is venture capital–backed, or 0 otherwise |
3 Month Return | The cumulative unadjusted return over the three months prior to the earnings announcement |
Appendix 2 Other JOBS Act Provisions
Pre-JOBS Act | Post-JOBS Act |
|---|---|
• Firms are required to provide three years of audited financial statements and five years of selected financial data. | • Firms can provide only two years of audited financial statements and two years of selected financial data. |
• Firms are required to disclose the Compensation Discussion and Analysis (CD&A) section, provide three years of compensation data for five executives, and include information on CEO to employee pay, the relation between compensation and firm performance, and payments upon termination. | • Firms may choose not to disclose the CD&A section or the information on CEO to employee pay, the relation between compensation and firm performance, and payments upon termination. Firms must report the summary and director compensation tables and related narratives. The compensation data is reduced to two years of information for three executives. |
• Since 2002, firms need to comply with the auditor attestation mandated by Section 404(b) of Sarbanes-Oxley (SOX) starting with the second annual report after a company goes public. | • Firms are exempt from the internal control audit required by Section 404(b) of SOX. |
• Since 2010, firms are subject to say-on-pay, say-on-frequency, and say-on-golden parachute rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. | • Firms may opt out of say-on-pay, say-on-frequency, and say-on-golden parachute shareholder advisory votes. |
• Firms must comply with new and revised accounting standards issued by the Financial Accounting and Standards Board (FASB) as they are passed. | • Firms can take advantage of an extended phase-in for accounting standards issued by FASB. A firm would only need to comply with these standards when it affects private companies. |
• Firms must comply with Public Company Accounting Oversight Board rules. | • Firms are exempt from future PCAOB rules, unless stated otherwise by the SEC. |
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Alhusaini, B., Chapman, K.L. & White, H.D. Private disclosure and myopia: evidence from the JOBS act. Rev Account Stud 28, 1570–1617 (2023). https://doi.org/10.1007/s11142-022-09672-6
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DOI: https://doi.org/10.1007/s11142-022-09672-6