Regulation Fair Disclosure May Increase Analyst Herding, Inhibit Firm Disclosure According to Study

New Haven, Conn., May 3, 2005—Regulation Fair Disclosure (FD) prohibits U.S. firms from disclosing information to only a select few analysts, instead requiring disclosures to the public. Although the Securities and Exchange Commission enacted Regulation FD with the aim of improving the quality of information reaching the market to help level the playing field between investors and analysts, it may have the opposite effect according to a new study.

The study “Unintended Consequences of Regulating Disclosures: The Case of Regulation Fair Disclosure” finds that by forcing disclosures to be widely disseminated, Regulation FD may unwittingly increase herding behavior, the tendency for analysts to quickly converge to a consensus, and consequently leave investors less informed and worse off. As a result of this concern, firms with investors’ priorities in mind may withhold disclosure, and therefore, Regulation FD may inhibit the very disclosure it was intended to widen.

The study was conducted by Brian Mittendorf and Ganapathi Narayanamoorthy of the Yale School of Management, Anil Arya of Fisher College of Business at Ohio State University, and Jonathan Glover of the Tepper School of Business at Carnegie Mellon University.

The researchers modeled the effects of Regulation FD on analyst interactions and the resulting implications for both investors and firms. Among the findings: if a firm’s disclosure is public, analysts may rationally mimic the firm’s announcement and ignore their own information. As a result, an investor is left with only firm information to guide her decisions.

The study also finds that private disclosure can delay herding and result in an investor having access to more diverse information, despite not having direct access to the firm’s information. For example, an investor will have access to both the information of analysts who were not privy to the firm’s disclosure and therefore reported their own information, as well as the information from analysts who did receive the disclosure.

“Selective disclosures can have the advantage of staving off herding behavior. And while selective disclosures limit investors’ access to information initially, the postponement of herding may mean investors gain in the end,” according to Professor Narayanamoorthy.

Professor Mittendorf concluded, “Though Regulation FD was created with an eye on curbing the behavior of financial market miscreants, our research shows that the limitations inherent in the regulation may harm firms and analysts whose intentions are pure. By fixating on the wrongdoings of a few, Regulation FD may be at risk for throwing the baby out with the bath water.”