Essays in information in financial markets

Essays in Information in Financial Markets Yifeng Guo This dissertation studies topics in the areas of information in financial markets. In the first chapter, Should Information be Sold Separately? Evidence from MiFID II, we examine whether selling information separately improves its production. We use a recent regulation in Europe (MiFID II) that unbundles research from transactions to investigate this question. We show that unbundling causes fewer research analysts to cover a firm. This decrease does not come from smallor midcap firms but is concentrated in large firms. Contrary to conventional wisdom, the reduction in the coverage quantity is accompanied by an increase in the coverage quality. Further analyses suggest that the enhancement of analyst competition could drive the results: inaccurate analysts drop out (extensive margin) and analysts who stay produce better-quality research (intensive margin). Our findings suggest that selling information separately improves information quality at the cost of reducing information quantity. The second chapter, Going Public or Staying Private: The Cost of Mandated Transparency, focuses on how transparency requirements in public markets affect firms’ decisions to go public or stay private. Public markets are transparent institutions, where disclosure is mandatory, and order flows observable. We show that transparency can lead to insufficient information acquisition and inefficient investment. Transparency of order flows in public markets discourages information acquisition. Insufficient information acquisition then exacerbates the cost of imperfect disclosure. When the short-term disclosable signal diverges from the long-run value of a project, entrepreneurs prefer opaque private markets where investors can bargain over the costs of acquiring information. Our model links a firm’s preference for public markets to the quality of disclosure metrics. Imperfect communication between investors and entrepreneurs caused by market transparency is a mechanism by which mandatory disclosure may destroy value, leading firms to remain private. In the third chapter, Active and Passive Funds: An Equilibrium Analysis, we provide a benchmark model to analyze investors’ equilibrium choices and the welfare consequences of active and passive investing. Active investing is costly, but it brings two benefits: investors can better hedge by freely trading each asset in the portfolio and can acquire information about the possible state of the world. Information acquisition decisions are strategic substitutes. Investors will become active until the net value of being active shrinks to zero. We show that when the cost of acquiring information is low, equilibrium features the coexistence of informed active investors and passive investors. When the cost of acquiring information rises, informed active, uninformed active and passive investors could coexist. Finally, if the cost of being uninformed active is sufficiently low, passive investing is dominated by active investing. The benchmark model allows future research to explore whether the market equilibrium induces the optimal level of information acquisition and active investment.