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The Twilight Zone: OTC Regulatory Regimes and Market Quality

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  • Bruggemann, Ulf

    (Humboldt University of Berlin)

  • Kaul, Aditya

    (University of Alberta)

  • Leuz, Christian

    (University of Chicago and University of PA)

  • Werner, Ingrid M.

    (OH State University)

Abstract

We analyze a comprehensive sample of more than 10,000 U.S. stocks in the OTC market. As little is known about this market, we first characterize OTC firms by trading venue and provide evidence on survival, success, frequency of venue changes, reporting status, and trading activity. A large number of new firms appear on the OTC market each year. With few exceptions, these new firms exhibit poor performance and rarely rise to trade on traditional exchanges. We analyze how market liquidity, price efficiency and crash risk, all of which capture aspects of market quality, differ across OTC venues and firms subject to different regulatory regimes, including federal securities and state blue sky laws. We show that OTC firms that are subject to stricter regulatory regimes have higher market liquidity and price efficiency, and lower return skewness. We also analyze OTC market features that are potential substitutes for SEC registration, such as publication in a securities manual or state merit reviews, and provide evidence on their capital-market effects. This evidence is relevant in light of the JOBS Act and the ensuing relaxation of SEC registration requirements. Overall, our results suggest that investors consider information and regulatory differences when trading OTC stocks.

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Bibliographic Info

Paper provided by Ohio State University, Charles A. Dice Center for Research in Financial Economics in its series Working Paper Series with number 2013-09.

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Date of creation: Aug 2013
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Handle: RePEc:ecl:ohidic:2013-09

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  1. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
  2. Michael Greenstone & Paul Oyer & Annette Vissing-Jorgensen, 2006. "Mandated Disclosure, Stock Returns, and the 1964 Securities Acts Amendments," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 399-460, May.
  3. Pástor, Luboš & Stambaugh, Robert F, 2002. "Liquidity Risk and Expected Stock Returns," CEPR Discussion Papers 3494, C.E.P.R. Discussion Papers.
  4. Chen, Joseph & Hong, Harrison & Stein, Jeremy C., 2001. "Forecasting crashes: trading volume, past returns, and conditional skewness in stock prices," Journal of Financial Economics, Elsevier, vol. 61(3), pages 345-381, September.
  5. Marosi, András & Massoud, Nadia, 2007. "Why Do Firms Go Dark?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(02), pages 421-442, June.
  6. Ross, Stephen A, 1989. " Information and Volatility: The No-Arbitrage Martingale Approach to Timing and Resolution Irrelevancy," Journal of Finance, American Finance Association, vol. 44(1), pages 1-17, March.
  7. Leuz, Christian, 2007. "Was the Sarbanes-Oxley Act of 2002 really this costly? A discussion of evidence from event returns and going-private decisions," Journal of Accounting and Economics, Elsevier, vol. 44(1-2), pages 146-165, September.
  8. repec:reg:wpaper:118 is not listed on IDEAS
  9. James C. Brau & Gardner Gee, 2010. "Micro-IPOs: An Analysis of the Small Corporate Offering Registration (SCOR) Procedure with National Data," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 14(3), pages 69-89, Fall.
  10. Leuz, Christian & Triantis, Alexander & Yue Wang, Tracy, 2008. "Why do firms go dark? Causes and economic consequences of voluntary SEC deregistrations," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 181-208, August.
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