Jobs and SOX: Information Design and Capital Formation

Abstract

Following the economic recession of 2009-11, the U.S. Congress approved legislation weakening the information disclosure requirements for small companies seeking financing in public and private markets. This policy has been criticized by analysts who warn against a reduction in investors’ willingness to invest, and hence in the amount of capital firms can raise. We argue that a risk sharing motive for trading implies that the new legislation is indeed consistent with its intended goal, and in fact, that a full disclosure requirement minimizes the capital that a firm can raise, given its business scale. Disclosure requirements that become more stringent at a larger business scale, such as those in the new legislation, may improve economic efficiency in the Pareto sense, increasing both financing of small and large firms and investors’ welfare. When liability is unlimited, disclosure that requires more detailed announcements of events with negative impact on return is ex ante favorable for the firm.