Andrew Abraham Schwartz has posted a very interesting new paper, which I think advances the ball significantly in the seeming dormant debate over mandatory disclosure. The gist of his argument is that we need to draw a "distinction between primary markets (where companies offer securities directly to investors) and secondary markets (where investors trade securities with one another)."
The two key economic concepts that undergird the modern theory of mandatory disclosure – agency costs and information underproduction – make good sense in the context of secondary markets. But if we shift our gaze to the primary context, these two ideas become largely irrelevant.
First, agency costs arise only after the securities have been sold and the investors worry that management will run the company in its own interest, rather than for the benefit of shareholders. The concept is irrelevant to the primary market, where promoters are trying to get investors to buy the securities at the outset. In the primary market, there are no agents and hence no agency costs; they are a feature of the secondary market alone.
Second, information underproduction is largely a function of the secondary market only. The idea here is that one company may have relatively easy access to information that would help participants in the secondary market more accurately assess the value of some other company or companies whose securities they trade. Information underproduction has almost nothing to do with primary offerings, because new issuers rarely have the same quantity or quality of relevant market information as existing public companies, and because a primary offering is a one-time event. Furthermore, promoters have powerful economic interests to divulge all the information that investors want, and thus there is likely little relevant company information missing from public view.
Highly recommended.
