| The Harvard Law School Forum on Corporate Governance and Financial ... By Andrew Tuch, co-editor, HLS Forum on Corporate... The European Union has become the first jurisdiction to propose a comprehensive framework for direct regulation and supervision of the entire investment funds industry – the proposed Directive on Alternative Investment Fund Managers. ... The Harvard Law School Forum... - http://blogs.law.harvard.edu/corpgov/ Proposed New European Regulation of Investment Funds(Editor’s Note: This post is by Selina Sagayam of Gibson, Dunn & Crutcher LLP.) The European Union has become the first jurisdiction to propose a comprehensive framework for direct regulation and supervision of the entire investment funds industry – the proposed Directive on Alternative Investment Fund Managers. The draft proposal which was published on 29 April aims to regulate investment funds within Europe which are not already covered by the UCITS regime, referred to in the proposal as alternative investment funds (AIFs). Rather than imposing requirements on the AIFs themselves, the proposals target AIF managers (AIFMs). It was considered that a broad regime focusing on those who manage investment funds rather than a defined set of entities prevalent in the investment fund world (e.g. hedge funds) would be more effective and less easy to circumvent, with enhanced scrutiny on leveraged hedge funds. Currently, this sector is regulated in the EU through a combination of fragmented national legislation as well as some general provisions of EU law, in addition to voluntary industry standards in certain cases (e.g. the Walker Guidelines in the UK). With investor protection as its fundamental aim, the European Commission’s rationale for the proposals is the introduction of harmonised regulatory standards and enhanced transparency. Early drafts of the directive had been leaked to the public weeks before and received a barrage of criticism particularly from different interest groups across various member states and not surprisingly, the hedge fund industry. The final draft proposals however have come under even greater attack with the UK Financial Services Secretary and key UK and European industry bodies (in particular the British Private Equity & Venture Capital Association and the European Private Equity & Venture Capital Association) voicing their strong opposition to proposals they consider are “deeply undesirable” and “immensely damaging” to industry. Some of the main points under the proposed legislation are set out below. Who Is Regulated? All EU domiciled AIFMs that meet either of the two threshold tests below will be regulated: • Leveraged AIFMs - Total assets under management equal to or above €100m (approx. US$1334m, £90m) where assets under management are acquired through use of leverage. • Non-leveraged AIFMs - Total assets under management equal to or above €500m (approx. US$670m, £448m) where: (i) none of the assets under management were acquired through use of leverage; and (ii) investments are locked into the fund for 5 years or more from the date of its constitution. …continue reading: Proposed New European Regulation of Investment Funds Disclosure and the Cost of CapitalIn our paper Disclosure and the Cost of Capital: Evidence from Firms’ Responses to the Enron Shock, which was recently updated after I presented it at the Law, Economics and Organizations seminar here at Harvard Law School, my co-authorCatherine Schrand and I exploit the Enron debacle as an exogenous shock for other U.S. firms and relate cost of capital shocks to subsequent disclosureresponses in an attempt to understand the critical link between disclosure and cost of capital. This approach is different from existing research, which has examined the relation cross-sectionally , relating disclosure levels to the cost of capital. Even though this research has found that firms with more extensive voluntary disclosure exhibit less information asymmetry and have a lower cost of capital, a causal interpretation of such findings has proved problematic due to endogeneity concerns for which valid instruments are very difficult to find. Our approach tackles the endogeneity concern in a different way, exploiting the Enron collapse acts as a natural experiment. In addition, there are a number of features of the Enron collapse that make this a powerful setting to address the broad question of the relation between disclosure and cost of capital. First, the shock led to investor concerns about a systematic lack of transparency in financial reporting. Hence, it seems reasonable to expect firms to consider disclosure responses. Second, the shock occurred during a relatively short window. Finally, it occurred during the fourth quarter of 2001. Thus, firms had the opportunity to respond in their annual financial reporting. Our sample comprises 1,868 U.S. firms with December fiscal-year ends and the required financial data from 1999 to 2001. Using this sample, we document that the cost of capital shocks are associated with an increase in the firms’ disclosures in their subsequent annual 10-K filings. Firms extend the number of pages in their 10-K filings, notably the sections containing the management discussion & analysis, related-party transactions, financial statements and footnotes. This link between cost of capital shocks and 10-K disclosure responses is robust to a broad set of alternative specifications. The increase in disclosure is particularly pronounced for firms that experience positive beta shocks and are likely to be more sensitive to their cost of capital because they have larger external financing needs and more growth opportunities. We also find that Arthur Anderson clients increase their 10-K pages and the section on related-party transactions more than firms that have other auditors, consistent with the idea that the disclosures are a response to the transparency concerns created by the Enron scandal. We do not find a significant relation between the beta shocks and changes in the length of firms’ annual earnings announcements. However, an analysis of firms’ interim disclosures after the shock suggests that firms increase the number of 8-K filings in response to the crisis. We show that the 8-K disclosures mitigate the effects of the shock but such interim disclosures do not eliminate the relation between the cost of capital shocks and disclosure in the 10-K, consistent with the idea that firms’ 10-K filings and interim disclosures are complementary activities to reduce the transparency problems during this time period. The latter finding is important because it suggests that the annual 10-K filing contains relevant information that can alleviate investor concerns, despite its lack of timeliness. Finally, we show that firms’ disclosure responses subsequently reduce firms’ costs of capital and hence mitigate the impact of the transparency crisis. The full paper is available for download here. |
Posts
