Public Float Research Articles

To Comply or Not to Comply: Understanding the Discretion in Reporting Public Float and SEC Regulations

AbstractThis paper documents how firms exercise discretion in defining affiliates and reporting public float in response to Securities and Exchange Commission regulations. I find that firms with higher expected compliance costs under section 404 of the Sarbanes‐Oxley Act of 2002 tend to classify more shares as affiliated and report lower public float. In contrast, firms issuing seasoned equity are less likely to underreport public float, possibly due to favorable regulatory treatment for large issuers. These incentives are weakened when future regulatory changes render float less important.

Ownership structure and performance: Evidence from the public float in IPOs

We investigate whether the post-IPO market performance of IPO stocks is related to the percentage of shares issued to the public, namely, the public float. We demonstrate that a non-linear relation exists between the public float and post-IPO returns. Specifically, as public float increases, long-run returns decrease for low levels of public float and increase for high levels of public float. This relation persists even after controlling for various firm characteristics. The best long-term performers are firms that sell either very little or sell most of their stock in the IPO. We suggest that the choice of public float level creates a trade-off between incentives to insiders and power granted to outsiders. This trade-off determines the non-linear relation found between the public float and long-run returns.

Determinants of auditor changes for non-accelerated filers

Significant accounting scandals and the imminent collapse of Arthur Andersen in 2001 precipitated a period of heightened regulatory response, most notably the enactment of the Sarbanes–Oxley Act of 2002. In the years that followed, the Securities and Exchange Commission created a separate class of non-accelerated filers (companies with public float of up to $75 million) and provided these companies with significant regulatory relief from certain financial reporting disclosure and auditing requirements, including the extension of scaled disclosure to these companies in 2007. Over the period of 2001 through 2007, as non-accelerated clients anticipated and responded to their different and evolving regulatory regime, audit firms were adjusting to the increased concentration in their market, a new monitoring structure, and significant changes to the scope of their work. We examine whether auditor–client misalignment is a significant determinant of auditor change during this period, particularly for non-accelerated filers, as large auditors sought to rebalance their client portfolios. We find evidence that auditor–client misalignment increases the likelihood of auditor change (resignation and dismissal) for non-accelerated, but not accelerated, filers. We also find that auditor–client misalignment increases the likelihood of downward changes to third-tier auditors for non-accelerated, but not accelerated, filers.

Do Small Firms Benefit from Auditor Attestation of Internal Control Effectiveness?

SUMMARYWhile auditor attestation of the effectiveness of internal control over financial reporting (ICFR) is required for firms with a public float of at least $75 million (accelerated filers), the Securities and Exchange Commission (SEC) has delayed auditor attestation for non-accelerated filers several times. The Dodd-Frank Act of 2010 exempts non-accelerated filers from auditor attestation. We examine the relation between auditor attestation and revenue quality for a sample of non-accelerated filers and small accelerated filers. We find that discretionary (abnormal) revenues, our proxy for revenue quality, are lower by about 1.5 percent of total assets for accelerated filers relative to non-accelerated filers. This finding holds even among firms whose management has certified their ICFR to be effective. Overall, the findings support the notion that auditor attestation of the effectiveness of ICFR benefits small accelerated filers via higher revenue quality. We believe our findings are timely and potentially informative to regulators, investors, and others.

The Sarbanes-Oxley Act and Corporate Investment: New Evidence from a Natural Experiment

Prior studies conclude that one of the economic costs of complying with the Sarbanes-Oxley Act (SOX) is lower corporate investment. U.S. firms with a public float above $75 million during 2002-2004 had to comply with Section 404 of SOX, whereas firms with a smaller public float in each of those three years could delay compliance until at least 2007. Using this setting as a natural quasi-experiment to isolate the effects that were uniquely due to Section 404 of SOX, we compare investment activities for the two groups of firms around the $75 million threshold. In contrast to prior studies, we do not find a reduction in investment for firms that had to comply with SOX relative to those that could delay compliance. Our results challenge the conventional wisdom that SOX caused firms to decrease corporate investment.

Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions

Measuring the efficiency of the market for a stock is important for a number of reasons, but such measurements have been widely utilized in securities class action litigation, particularly to justify certification of cases as appropriate for class action treatment. We provide a general methodology to measure the arbitrage risk, which is a negative proxy for the market efficiency, of a stock for any relevant period. We apply this methodology to calculate the arbitrage risk of each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the Capital Asset Pricing Model of the stock (positively). These findings seem inconsistent with “conventional wisdom” and with the understanding that courts use in applying notions of market efficiency to class certification decisions, but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative) and institutional ownership (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.

Arbitrage Risk and Market Efficiency – Applications to Securities Class Actions

Measuring the efficiency of the market for a stock is important for a number of reasons, but such measurements have been widely utilized in securities class action litigation, particularly to justify certification of cases as appropriate for class action treatment. We provide a general methodology to measure the arbitrage risk, which is a negative proxy for the market efficiency, of a stock for any relevant period. We apply this methodology to calculate the arbitrage risk of each U.S. exchange-listed common stock for every calendar year from 1988 to 2010. We find that market efficiency is significantly affected by turnover (negatively), the number of market makers for Nasdaq stocks (negatively), and serial correlation in the Capital Asset Pricing Model of the stock (positively). These findings seem inconsistent with “conventional wisdom” and with the understanding that courts use in applying notions of market efficiency to class certification decisions, but we show that our findings are consistent with economic logic. The relations between market efficiency and market capitalization (positive), bid-ask spread (negative) and institutional ownership (positive) are consistent with conventional wisdom. The impact on market efficiency of the number of securities analysts following a stock and the public float ratio of a stock are of ambiguous significance.

Ownership Structure and Performance: Evidence from Public Float in IPOs

We investigate whether the post-IPO market performance of IPO stocks is related to the percentage of shares issued to the public, namely, the public float. We demonstrate that a non-linear relation exists between the public float and post-IPO returns. Specifically, as public float increases, long-run returns decrease for low levels of public float and increase for high levels of public float. This relation persists even after controlling for various firm characteristics. The best long-term performers are firms that sell either very little or sell most of their stock in the IPO. We suggest that the choice of public float level creates a trade-off between incentives to insiders and power granted to outsiders. This trade-off determines the non-linear relation found between the public float and long-run returns.

The Unintended Effects of the Sarbanes-Oxley Act

The Sarbanes-Oxley Act (SOX) was passed in the wake of several scandals that rocked corporate America in 2001 and 2002. The objective behind SOX was to improve corporate governance by improving accounting disclosures. Compliance with Section 404 is considered by many to be the most costly requirement of SOX and has been argued to be a disproportionate burden for small firms. Consequently, firms with a public float below $75 million were granted several exemptions from compliance. We document an unintended effect of these exemptions: a weakening of corporate governance through a weakening of the market for corporate control.

The Effect of SOX Section 404: Costs, Earnings Quality, and Stock Prices

ABSTRACTThis paper exploits a natural quasi‐experiment to isolate the effects that were uniquely due to the Sarbanes–Oxley Act (SOX): U.S. firms with a public float under $75 million could delay Section 404 compliance, and foreign firms under $700 million could delay the auditor's attestation requirement. As designed, Section 404 led to conservative reported earnings, but also imposed real costs. On net, SOX compliance reduced the market value of small firms.

The Use of Discretion in Reporting Public Float

This paper documents how firms exercise discretion in defining affiliates and reporting public float in response to SEC regulations. I find that firms with higher expected compliance costs under Section 404 of the Sarbanes-Oxley Act (SOX) of 2002 tend to classify more shares as affiliated and report lower public float. In contrast, firms issuing seasoned equity are less likely to underreport public float, possibly due to favorable regulatory treatment for large issuers. These incentives are weakened when future regulatory changes render float less important.

Unintended Consequences of Granting Small Firms Exemptions from Securities Regulation: Evidence from the Sarbanes‐Oxley Act

ABSTRACTThis paper provides evidence about the unintended consequences arising when small companies are exempted from costly regulations—these firms have incentives to stay small. Between 2003 and 2008, the SEC postponed compliance with Section 404 of the Sarbanes‐Oxley Act of 2002 (SOX) for “non‐accelerated filers” (firms with public float less than $75 million). We hypothesize and find that some of these firms had an incentive to remain below this bright line threshold. Moreover, we document that these firms remained small by undertaking less investment, making more cash payouts to shareholders, reducing the number of shares held by non‐affiliates, making more bad news disclosures, and reporting lower earnings than control firms. Finally, there is no evidence that firms remaining small are doing so to maintain insiders' private control benefits. These findings have implications beyond SOX because numerous federal and state regulations exempt small firms via bright line size thresholds.

Discussion of Unintended Consequences of Granting Small Firms Exemptions from Securities Regulation: Evidence from the Sarbanes‐Oxley Act

(GWZ) examine a potential unintended consequence of the SEC’s use of bright-line thresholds for compliance with reporting regulations. In particular, the authors consider whether the SEC’s postponement of compliance with Section 404 of the Sarbanes-Oxley Act (SOX) for “non-accelerated filers” (firms with a public float of less than $75 million) provided firms with an incentive to stay small. The authors find that non-accelerated filers are more likely to remain below the $75 million threshold than are accelerated filers. They also investigate a variety of actions that non-accelerated filers might take in order to keep their public float below $75 million.

The Effect of SOX Section 404: Costs, Earnings Quality and Stock Prices

This paper exploits a natural quasi-experiment to isolate the effects that were uniquely due to Sarbanes-Oxley Act (SOX): US firms with a public float under $75 million could delay Section 404 compliance, and foreign firms under $700 million could delay the auditor’s attestation requirement. As designed, Section 404 led to conservative reported earnings, but also imposed real costs. Net-in-net, SOX compliance reduced the market value of small firms.

The Role of Book Income, Web Traffic, and Supply and Demand in the Pricing of U.S. Internet Stocks

In this paper I assess the degree of similarity in the cross-sectional pricing of Internet and non-Internet stocks during the tumultuous year of 2000. Despite large differences in their economic fundamentals, I find that the equity market values of Internet firms with immaterial web traffic, firms that are randomly selected, and firms that went public at the same time as Internet firms are similarly related to analysts' forecasts of earnings in 2001 and the long-term rate of growth in earnings. This is not the case for firms with intensive web traffic. I also find that at the peak of Internet prices in March 2000 the market rewarded losses of web-traffic-intensive firms but did not reward profits, while after the peak the market reversed its view, rewarding profits but not losses. Beyond earnings, web traffic is significantly positively priced both at and after the Internet peak. However, I find no evidence that two proxies for supply and demand forces – the degree of public float and short interest – are value-relevant for Internet firms. Overall, I argue that there are enough similarities in the cross-sectional pricing of Internet and non-Internet firms to make it unlikely that the pricing of Internet stocks during 2000 was entirely irrational. Moreover, any irrationality in the prices of Internet stocks cannot be linked to public float and short interest. JEL classifications: G12, G14, M41.

The Fiscal Consequences of Privatisation: Australian evidence on privatisation by public share float

Privatisation has become a common government policy in many countries. This paper summarises the salient features of privatisations by public share float in Australia during the period 1989 to 1997. The costs associated with these privatisations are examined, including both direct costs and the opportunity cost of Australian governments selling assets cheaply. Furthermore, the impact that such sales have on the net worth of the public sector is estimated. The results suggest that there is a cost of underpricing. There is also some evidence that the effect on the public sector net worth may be negative. However, in some cases where the enterprise sold is inefficient the government may realise a gain.

The Role of Economic Fundamentals, Web Traffic, and Supply and Demand in the Pricing of U.S. Internet Stocks

In this paper I measure the importance of three groups of factors in the pricing of U.S. Internet stocks: economic fundamentals, web traffic, and supply and demand forces. Using log-linear regression on a panel of data for Net and non-Net stocks on 2/1/2000, I highlight five findings. First, contrary to popular perception, neither web traffic or supply and demand forces drive Net stock prices. Rather, economic fundamentals in the form of current book equity, forecasted one-year ahead earnings and forecasted long-run earnings growth dominate in explaining cross-sectional variation in Net stock prices. Second, incremental to economic fundamentals, Net firms' equity market values are reliably related to only one measure of web traffic-the number of unique visitors to the firm's web site. Net firms' equity market values are unrelated to the number of page views, hours spent at the website, the average age and the average income of visitors. Third, over and above economic fundamentals and web traffic, Net firms' equity market values are reliably correlated with proxies for supply and demand forces in the form of public float, short interest and institutional ownership. Fourth, the value-relevance of supply and demand factors only exists for Net firms with no business-to-consumer web traffic, suggesting that the public familiarity that business-to-consumer e-commerce creates leads to greater capital market efficiency in the pricing of their stock. Finally, the equity values of non-Net stocks are unrelated to supply and demand forces, yet are strongly associated with economic fundamentals. Overall, I conclude that while the pricing of U.S. Net stocks is dominated by expectations of near- and long-term profitability, they are also uniquely impacted by non-traditional value-drivers in ways that non-Net firms are not.

Measuring Securities Market Efficiency in the Regulatory Setting

In the Aircraft Carrier, the Securities and Exchange Commission (SEC) proposed changes in federal securities disclosure requirements in attempt to enhance and facilitate the process of issuing new securities. Under the proposed regulatory regime, the registration process would be simplified so that many larger, more experienced issuers would be able to use a new, shorter registration statement called Form B (as opposed to the more extensive Form A) whenever they sell securities to the public. To qualify to use Form B, a company with at least twelve months reporting history under the Exchange Act must either have a public float of $75 million or more and average daily trading volume (ADTV) of $1 million or more, or have a public float of $250 million or more. In this paper, we argue that the SEC's study of capital market efficiency employs too broad a definition of what constitutes an who represents important conduit for information between a company and its investors. We adjust the definition of analyst to more accurately reflect only those analysts whose research effectively disseminates information to investors in the market (sell-side analysts) and find that the proposed numerical cutoffs for the use of Form B are set much too low to insure adequate analyst following. This finding is consistent with evidence we present that a substantial percentage of companies eligible to use Form B have low levels of institutional investor shareholdings. Based on a sample of companies whose stock price was greater than $1.00 on 12/31/99, we find that 3,413 (43.3%) of firms in the sample qualify to file Form B using the SEC's proposed numerical cutoffs. Using First Call's consensus earnings estimate service, we examine the analyst following of firms that have a market capitalization greater than $250 million and find that 26.1% of these firms have less than three analysts compared to the 5.0% reported by the SEC. We also examine the SEC's second criteria (market capitalization greater than $75 million and average daily trading volume (ADTV) of $1 million) and find that 38.1% of companies have less than three analysts compared to the 14.0% reported by the SEC. We argue that equity or sell-side analyst following represents important source of information to investors and should be considered when establishing criteria for relaxed reporting requirements when companies issue securities.

Demand Curves for Stocks Do Slope Down: New Evidence from an Index Weights Adjustment

Weights in the Toronto Stock Exchange 300 index are determined by the market values of the included stocks' public floats. In November 1996, the exchange implemented a previously announced revision of its definition of the public float. This revision, which increased the floats and the index weights of 31 stocks, conveyed no information and had no effect on the legal duties of shareholders. Affected stocks experienced statistically significant excess returns of 2.3 percent during the event week, and no price reversal occurred as trading volume returned to normal levels. These findings support downward sloping demand curves for stocks.

Measuring Securities Market Efficiency in the Regulatory Setting

RANDALL S. THOMAS [*] JAMES F. COTTER [**] I INTRODUCTION In November 1998, the Securities and Exchange Commission (SEC) proposed a modification to the federal securities law disclosure requirements to facilitate the process of issuing new securities. In a massive document, nicknamed the Aircraft Carrier, [1] the SEC sought public comments on a variety of proposed changes to the federal securities laws that were designed to minimize the cost and delays associated with issuing securities, while continuing to provide the public with the information that it needed to make investment decisions. Although the public comment period on these proposals has passed without any apparent action by the SEC, the policy questions raised by the Aircraft Carrier continue to be important ones. This article addresses one of the key issues that the Aircraft Carrier raised: How can we determine when companies should be able to issue simplified disclosure documents? In this proposed regulatory regime, the SEC suggested the use of a simplified registration statement, Form B, for larger, more experienced issuers, while other companies would continue to make traditional extensive disclosures using Form A whenever they sell securities to the public. [2] The SEC's proposal would have limited Form B disclosure to firms who had a public float greater than $250 million, or had a combination of $75 million in public float and average daily trading volume (ADTV) greater than $1 million. [3] Similar to the way that the short form and shelf registration systems introduced by the SEC in the early 1980s allowed companies to take their securities to market more efficiently and quickly, the proposed Form B disclosure rules were intended to decrease the amount of time and to lower the cost associated with selling a company's securities. The theoretical basis for permitting simplified disclosure for some companies, but not for others, rests on the efficient capital markets hypothesis. This theory postulates that the market for a company's securities can be said to be efficient if, for a specific set of information, the security's market price is the same as it would be if all investors possessed this information. [4] Securities that trade in efficient markets have rapid price adjustments to new information, whereas those in inefficient markets do not. Today, it is well accepted that the efficient capital markets hypothesis constitutes the theoretical underpinning for the federal securities laws disclos ure policy. [5] The SEC's premise in the Aircraft Carrier proposals was that companies whose shares are traded in an efficient capital market should be permitted to file simplified registration statements that incorporate by reference many of their other federal securities law filings. [6] While we agree with this fundamental premise, we believe that the regulatory criteria that the SEC proposed for issuers to be eligible to file on the new Form B failed to capture market efficiency adequately. In this article, we argue that the SEC's study of the underlying factors that lead to capital market efficiency--which uses following for a company's stock as a proxy for market efficiency--employed too broad a definition of what constitutes an analyst for purposes of measuring market efficiency. We also believe that the SEC failed to consider other important available proxies for market efficiency, particularly the level of institutional investors' stock ownership in these companies. When we adjust the definition of to reflect more accurately only those analysts whose research effectively disseminates information to investors in the market, we find that the proposed numerical cutoffs for the use of Form B were set much too low. This conclusion is confirmed when we examine the distribution of institutional investor stock ownership in American companies, and reach the same result. …