November 6, 2012
Disclosure and value creation ... or not
Two interesting papers that raise the question of the true value of disclosure. The first is by Steven Davidoff and Claire Hill, Limits of Disclosure. Disclosure has been a common regulatory device since it was by Louis Brandeis ("Sunlight is said to be the best of disinfectants", Other People's Money). Indeed, our system of securities regulation is built upon this premise. Davidoff and Hill look at just how effective disclosure was in the run up to the financial crisis with respect to retial investors and in regulation of executive compensation. They come away disappointed:
The two examples, taken together, serve to elucidate our broader point: underlying the rationale for disclosure are common sense views about how people make decisions — views that turn out to be importantly incomplete. This does not argue for making considerably less use of disclosure. But it does sound some cautionary notes. The strong allure of the disclosure solution is unfortunate, although perhaps unavoidable. The admittedly nebulous bottom line is this: disclosure is too often a convenient path for policymakers and many others looking to take action and hold onto comforting beliefs in the face of a bad outcome. Disclosure’s limits reveal yet again the need for a nuanced view of human nature that can better inform policy decisions.
In another paper, Jeffrey Manns and Robert Anderson, The Merger Agreement Myth, take on the question of whether M&A lawyers are really creating any value or if they are just haggling over nits that no one cares about. Manns and Anderson conduct an event study to figure out whether there is value to all that drafting. They take advantage of the fact that not all merger agreements are filed with the SEC on the same day they are announced. So, they look for stock price changes that they can attribute to the addition of new information after the market learns about the terms of the merger agreement. If lawyers add value, they hypothesize that prices should rise after the market has learned the terms of the agreement - that's the value attributable to lawyers. It's basically a disclosure argument. If disclosure works, then the market should be able to instantly - or reasonably quickly - absorb new information and have that information reflected in stock prices. Like Davidoff and Hill, Manns and Anderson come away disappointed:
Our analysis shows that there is no economically consequential market reaction to the disclosure of the acquisition agreement. Markets appear to recognize that parties publicly committed to a merger have strong incentives to complete the deal regardless of what legal contingencies are triggered. We argue that the results suggest that M&A lawyers are fixated on the wrong problems by focusing too much on negotiating “contingent closings” that allow clients to call off a deal, rather than “contingent consideration” that compensates clients for closing deals that are less advantageous than expected. This approach can enable M&A lawyers to protect clients against the effects of the clients’ own managerial hubris in pursuing mergers that may (and often do) fall short of expectations.
So, disclosure as a regulatory device, or as a determiner of value, is not that successful and suggests we start looking elsewhere.
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