Disclosure Costs, Regulation, and the Expansion of the Private-Placement Market

Abstract

The private-placement debt market has grown dramatically in recent years. Private placements have a “competitive advantage” over public placements in being exempt from many regulations, including disclosure procedures and auditing requirements. Here, a model is developed to explain the growth in the private-placement market. Corporate borrowers choose between public and private placement of debt so as to minimize borrowing costs. Borrowers in the public-placement market incur higher regulatory cost, but are also able to signal accurately their true risk of default. In private placements, there is an asymmetric information problem. This results in an equilibrium where the debt market gets partitioned between private and public placements. It is shown that raising regulatory costs will lead to an expansion of the market share of private placements. It will also lead to an increase in the overall default rate on corporate debt.