A fundamental principle underlying modern capital markets is the concept of a level playing field. In October 2000, the SEC implemented Regulation Fair Disclosure in recognition of the risks that “a privileged few gain an informational edge – and the ability to use that edge to profit – from their superior access to corporate insiders, rather than from their skill, acumen, or diligence”. This followed numerous studies that information asymmetry creates transaction costs by introducing adverse selection, particularly leading to a reduction in liquidity as uninformed investors are less willing to trade for fear of incurring trading losses to informed investors.

Despite this, most UK stock market observers would recognise the disparity in access to information that still exists between institutional investors and private investors and we have discussed previously the negative implications of this for the small-cap sector in particular.

What's driving Information Asymmetry?

As researchers Blankespoor, Miller and White have pointed out, to be effective, not only is it important that price sensitive information is disclosed, but it must also be disseminated and readily available to all investors. In reality, this is often not the case. The typical disclosure process for price-sensitive information by a company begins when management creates a formal press release with guidance from its lawyers and public relations advisors. Once prepared, the tool for the disclosure in the UK market is the release of a regulatory news statement via a Primary Information Provider. The PIP newswire service in turn distributes the news to various information intermediaries, such as the press or analysts and companies typically take the time following an announcement to give media interviews and to brief research analysts. These intermediaries select some subset of the press releases on a given day to deliver to the public or their clients, usually adapted and rewritten by the intermediary. This process provides a third-party legitimacy to company disclosure that a press release or earnings statement does not usually have on its own, while also providing important contextual information and relevance to the release (such as an analysis of the impact of the news on the assumptions of a broker’s model and their price target). 

While this system operates reasonably well for the larger companies where there is a combination of broad media interest, analyst coverage and institutional ownership, the flaws are much more apparent in the small-cap sector. This is for…

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