Fair Disclosure and Investor Asymmetric Awareness in Stock Markets

The US Security and Exchange Commission implemented Regulation Fair Disclosure in 2000, requiring that an issuer must make relevant information disclosed to any investor available to the general public in a fair manner. Focusing on firms that are affected by the regulation, we propose a model that characterizes the behavior of two types of investors\----one professional investor and many small investors\----in the regimes before and after the regulation, i.e., under selective disclosure and fair disclosure. In particular, we introduce the concept of awareness and allow investors to be aware of relevant information symmetrically or asymmetrically. We show that with symmetric awareness, fair disclosure induces both a low cost of capital and a low cost of information, therefore making the market efficient. Also, the professional investor collects an equal level of information under fair disclosure than under selective disclosure. However when small investors are not fully aware, fair disclosure still induces a low cost of capital but may induce a high cost of information. The professional investor may deliberately collect less information under fair disclosure than under selective disclosure. With asymmetric awareness, our theory produces predictions that match the empirical findings by Ahmed and Schneible Jr. (2004) and Gomes, Gorton, and Madureira (2006). They find that small and complex firms are negatively affected by the regulation. We also show that fair disclosure improves the welfare of small investors when they are extremely unaware. Such results are not compatible with the standard symmetric awareness assumption.