This study examines the change in capital structure as an economic consequence of Regulation Fair Disclosure (FD). Regulation FD, implemented by the Securities and Exchange Commission (SEC) in October 2000, puts more constraints on corporate disclosure in the equity market than in the debt market. In the equity market, the regulation prohibits any selective disclosure of material information by firms to favored market professionals. In the debt market, on the other hand, it grants an exemption to credit rating agencies and does not apply to banks. Because of the standard differential requirements between the two markets, firms who seek to raise capital may have incentives to turn to the debt market where private disclosure is still available. My results support this prediction.
This paper contributes to the literature by connecting the regulatory effects on the information environment to an economic outcome, the change in capital structure. Most academic researchers have focused on FDos impact on the information environment. My paper extends this research by empirically showing that, through its influences on the information environment, Regulation FD also influences financing choices. Changing corporate financing behavior is an economic consequence that the regulators might not expect when they issued Regulation FD.
In addition, this paper shows that while larger firms tend to enjoy a better information environment post FD, smaller firms tend to be negatively affected by FD and to switch to the debt market. From a policy perspective, these results demonstrate that one size does not fit all in disclosure requirements. All these findings are important for an overall understanding of the effect of the regulation.
I combine the literatures on corporate disclosure and financing choices to develop the hypothesis that FD affects capital structure. In the disclosure literature prior research has shown that when a firm reduces the quantity or quality of voluntary disclosure, the firm becomes more opaque and will face higher information asymmetry among investors (Brown et al. (2004); Brown and Hillegeist (2007)). Higher information asymmetry among investors further leads to higher cost of capital (Easley and OoHara (2004); Easley et al. (2002)). The conclusion of these two literatures is that through asymmetric information among investors, corporate disclosure can affect a firmos financing costs.
Regulation FD narrows firmsodisclosure channels in the equity market by eliminating the selective disclosure channel. Its impact is unlikely to be uniform across firms. While some firms may be able to maintain the same level of disclosure as before, others may not be able to do so (Gomes et al. (2007); Wang (2007)). For those who fail to maintain the same level of disclosure, they are now facing higher cost of equity capital. These firms who seek to raise capital have incentives to turn to the debt market where private disclosure is still available. My results support this prediction.
