Should We Regulate Financial Information?

Regulations that require asset issuers to disclose payoff-relevant information to potential buyers sound like obvious measures to increase investor welfare. But in many cases, such regulations harm investors. In an equilibrium model, asset returns compensate investors for risk. By making payoffs less uncertain, disclosure reduces risk and therefore reduces return. As high-risk, high-return investments disappear, investor welfare falls. Of course, information is still valuable to each individual investor. But acquiring information is like a prisoners’ dilemma. Each investor is better off with the information, but collectively investors are better off if they remain uninformed. The only cases in which providing information improves investors’ welfare are ones where there would otherwise be severe asymmetric information. Using a model of information markets, the paper explores when such outcomes are likely to arise. When we extend the model so that financial markets with information allocate the real capital stock more efficiently, these conclusions do not change. Disclosure improves efficiency, but more efficient firms do not have more risk and therefore do not offer investors higher return. Instead, they simply command a higher price, which only benefits the asset issuer. Since the efficiency gains are fully internalized by asset issuers, who can choose to disclose without disclosure being mandatory, the efficiency argument is not a logical rationale for regulation. ∗[email protected], and [email protected]. A previous version of this paper circulated under the title “De-regulation of markets for financial information.” Thanks to David Backus, Peter DeMarzo, Darrell Duffie, Pete Klenow, Andy Skrzypacz, Stijn Van Nieuwerburgh, and Xavier Vives for comments. Thanks also to seminar and conference participants at 2012 AEA meetings, UC Davis, Santa Barbara LAEF conference, CEPR conference on information in macroeconomics, Society for Economic Dynamics conference, Stanford, SITE, Universidad de San Andrés, Universidad Di Tella, Fundacao Getulio Vargas, PUC, Maryland, New York Federal Reserve, NYU University of Pennsylvania, Minneapolis Federal Reserve, and Wisconsin. Laura Veldkamp thanks the Hoover Institution for their hospitality and financial support through the national fellows program. Thanks to Isaac Baley and Krishna Rao for helpful research assistance.