20:12 27/2/2020 RFS-OP-REVF190106.tex Page: 1367 13671411 Informing the Market: The Effect of Modern Information Technologies on Information Production Meng Gao Gies College of Business, University of Illinois at Urbana-Champaign Jiekun Huang Gies College of Business, University of Illinois at Urbana-Champaign Modern information technologies have fundamentally changed how information is disseminated in financial markets. Using the staggered implementation of the EDGAR system from 1993 to 1996 as a shock to information dissemination technologies, we find evidence that internet dissemination of corporate disclosures increases information production by corporate outsiders. Trades by individual investors, especially those with access to the internet, become more informative about future stock returns following the EDGAR implementation. The amount and accuracy of information produced by sell- side analysts increase after the implementation. These results suggest that greater and broaderinformationdisseminationfacilitatedbymoderninformationtechnologiesimproves information production. (JEL G12, G14) Received June 1, 2018; editorial decision July 12, 2019 by Editor Itay Goldstein. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online. Awell-functioningsecuritiesmarketrequiresthatabroadbaseofinvestorshave access to corporate information and process such information to promote price efficiency and facilitate capital formation. The advent of modern information technologies has dramatically changed how information is disseminated in We thank Itay Goldstein (the editor), two anonymous referees, Heitor Almeida, Ferhat Akbas, Paul Brockman, Mara Faccio, Mariassunta Giannetti, Kathleen Hanley, Jack He, David Hirshleifer, Jianfeng Hu, Paul Irvine, Tim Johnson, Eric Kelley, Paul Koch, Mathias Kronlund, Laura Li, Lei Li, Wei Li, Vikram Nanda, Neil Pearson, Joshua Pollet, Jeff Pontiff, Matt Spiegel, Avanidhar Subrahmanyam, Alexei Tchistyi, Paul Tetlock, Stijn Van Nieuwerburgh, Alex Wagner, Chengwei Wang, Rong Wang, Scott Weisbenner, Baozhong Yang, Liyan Yang, Hao Zhang, Haibei Zhao, Mengxin Zhao, Haoxiang Zhu, and Wei Zhu; and seminar participants at the 2019 American Finance Association (AFA) meetings, the 2018 SFS Cavalcade, the 2018 Financial Intermediation Research Society (FIRS) Conference, the 2017 China International Conference in Finance, the Securities and Exchange Commission, Kansas University, Lehigh University, Nanjing University, University of Illinois at Urbana-Champaign, University of St. Gallen, University of Zurich, and Xiamen University for comments and helpful discussions. Chris Lien, Jianzhang Lin, and Zhongnan Xiang provided excellent research assistance. We are responsible for any remaining errors. Supplementary data can be found on The Review of Financial Studies web site. Send correspondence to Jiekun Huang, Department of Finance, Gies College of Business, University of Illinois at Urbana-Champaign, 1206 South Sixth Street, Champaign, IL 61820. E-mail: huangjkillinois.edu. The Review of Financial Studies 33 (2020) 13671411 The Author(s) 2019. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please e-mail: . doi:10.1093/rfs/hhz100 Advance Access publication September 6, 2019 Downloaded from by guest on 06 May 2020 20:12 27/2/2020 RFS-OP-REVF190106.tex Page: 1368 13671411 The Review of Financial Studies / v 33 n 4 2020 financial markets by making a large amount of information available to a broad base of financial market participants in real time at low costs. Investors nowadays can get immediate access to corporate disclosures as well as other marketparticipantsopinionsdisseminatedthroughtheinternettogaininsights into firms fundamental value. In the past few decades, a series of regulatory changes have been made to make use of modern information technologies to improve the accessibility of information to the public. For example, the SEC launched the EDGAR system in 1993 to move corporate disclosure from the print era to the digital age, and in 2013 the SEC allowed public companies to use social media sites to announce key information to investors. Yet, despite the dramatic changes brought about by modern information technologies in the dissemination of information, the effects of modern information technologies on information production by market participants remain underexplored. Modern information dissemination technologies can have two opposite effects on information production by corporate outsiders. 1 On the one hand, more timely and extensive dissemination of information facilitated by modern information technologies may crowd out information production by market participants.Thismayarisebecauseofatleastthreereasons.First,whenpublic informationiswidelydisseminated(i.e.,moreinvestorsbecomeinformedabout the information), prices may reveal more of the information (Grossman and Stiglitz 1980). Because information processing takes time, the advantage of becoming an information processor decreases, resulting in reduced intensity of information processing activities (e.g., Dugast and Foucault 2018). Second, because public information can serve as a coordinating device for investors beliefs, greater dissemination of public information may cause investors to overweight public information and underweight private information. This may reduce stock price efficiency when the precision of private information is high (Morris and Shin 2002; Amador and Weill 2010). For example, Shiller (2006) argues that mass dissemination of information by the media may negatively affect the efficiency of asset prices by creating similar thinking among large groups of people, causing “an avoidance of individual assessment of quantitative data.”Third, the availability of large amounts of information may create an information overload problem (e.g., Barber and Odean 2001; Shapiro and Varian 1999), reducing the attention allocated to information processing.Theseconsiderationssuggestthattheadventofmoderninformation technologies may dampen the incentive to produce information and therefore reduce pricing efficiency. On the other hand, a crowding-in effect may arise for at least two reasons. First, modern information technologies can reduce the cost of accessing corporate disclosures and extracting value-relevant information from the 1 Greaterandbroaderdisseminationofinformationfacilitatedbymoderninformationtechnologiescanhaveadirect positive effect on investors information and market efficiency. In this paper, we focus on indirect information production effects and try to distinguish the indirect effects from the direct effect wherever possible. 1368 Downloaded from by guest on 06 May 2020 20:12 27/2/2020 RFS-OP-REVF190106.tex Page: 1369 13671411 Informing the Market disclosures, which may induce greater intensity of information production by market participants. Other things equal, the net profit information producers derive from producing information increases as the cost of information production declines (see, e.g., Verrecchia 1982; Kim and Verrecchia 1994). As Verrecchia (1982) argues, “as technological improvements permit more information to be obtained at the same cost, traders increased information acquisition results in prices revealing more information.” Second, greater dissemination of corporate disclosures can reduce the uncertainty traders face by allowing stock prices to reflect more of the information contained in the disclosures, which may cause traders to acquire and trade on information about other fundamentals of the firms (Goldstein and Yang 2015). Thus, greater dissemination of information facilitated by modern information technologies may increase the incentives of market participants to produce information and, as a result, improve pricing efficiency. Therefore, the net effect of modern information technologies on information productionisultimatelyanempiricalquestion.Inthispaper,weinvestigatethis question by exploiting the staggered implementation of the EDGAR system in 19931996 as a shock to information dissemination technologies. Before the implementation of EDGAR in 1993, publicly traded corporations had to transmit multiple paper copies of filings to the SEC, and the three public reference rooms of the SEC (in Washington DC, New York, and Chicago) were the ultimate sources of these filings. The SEC introduced the EDGAR system in February 1993 to enable companies to file electronically to facilitate the dissemination of information to the public in a timely manner. Importantly, the SEC required that all public companies began filing to EDGAR in 10 discrete groups, with companies in the first group starting to file on EDGAR in April 1993 and companies in the last group starting in May 1996. Thus, the staggered nature of the implementation of the EDGAR system provides a set of counterfactuals for how information production would have changed in the absence of a change in information dissemination technologies and so allows us to disentangle the effect of information technologies on information production from other confounding factors. For an omitted variable to explain our findings, it would have to affect different groups of companies at discrete points in time as specified in the phase-in schedule. In this paper, we focus on information production by two groups of market participants, namely, individual investors and sell-side financial analysts, for two reasons. First, both individual investors and sell-side analysts play the role of information producers in the financial markets. Specifically, growing evidence suggests that individual investors produce information about stocks (e.g., Kaniel et al. 2012; Kelley and Tetlock 2013, 2017). 2 Because EDGAR makes corporate filings, which were particularly costly to obtain for individual 2 AsKanieletal.(2012)andKelleyandTetlock(2013)argue,individualstradesmaycontaininformationbecause, whileeachindividualinvestormayhaveonlynoisyinformation,aggregatingtheinformationthroughthetradesof 1369 Downloaded from by guest on 06 May 2020 20:12 27/2/2020 RFS-OP-REVF190106.tex Page: 1370 13671411 The Review of Financial Studies / v 33 n 4 2020 investors before the implementation, readily accessible on the internet, it might significantly affect individual investors. There is also a large literature that studies the role of sell-side financial analysts as information intermediaries in the stock market (see, e.g., Healy and Palepu 2001, for a comprehensive review of this literature). Second, for both groups, we can directly observe their behavior at a relatively high frequency, which enables us to construct proxies of information production around specific points in time. In particular, we use the trading data from a large discount brokerage database (the LDB data set) used by Barber and Odean (2000) and analyst forecasts data from I/B/E/S database. 3 More important for our purposes, the LDB data set allows us to identify investors with access to the internet who are directly affected by the EDGAR shock. Using a comprehensive set of firms covered in the phase-in schedule of the EDGAR system, we find evidence suggesting that the crowding-in effect dominates the crowding-out effect for both individual investors and sell-side analysts. Specifically, we find that individual investors net buying following an earnings announcement of a stock becomes more informative about future stock returns after the stock becomes subject to mandatory filing on EDGAR. The economic magnitude is nontrivial. For example, a 1-standard-deviation increase in net buying by individual investors during the 20 trading days post- announcement is associated with 1.089 percentage points higher subsequent 3-month cumulative abnormal returns (CARs) after the stock becomes an EDGAR filer than before, which is economically nontrivial considering that the 3-month CAR has a mean of 0.592% and a standard deviation of 21.668%. Importantly, we are able to identify which investors have access to the internet based on whether they placed a trade through the internet in the past. While internetusersaccountforonly12%oftheinvestorsinoursample,theincreasein stockreturnpredictabilityaftertheEDGARimplementationisdrivenprimarily by trades placed by these investors. We also find evidence suggesting that the increase in trade informativeness post-EDGAR is mainly driven by investors that are presumably more skilled in information production. These results suggest that the crowding-in effect dominates the crowding-out effect, thereby resulting in more information production by individual investors, especially those with ready access to the internet. a large number of individuals may result in relatively precise signals. In addition, individuals might be especially well positioned to exploit private information through their trades, because they tend to trade in small quantities and are not subject to the agency problems, career concerns, or liquidity constraints that institutional managers typically face. These studies focus on a subset of individuals trades (e.g., those around specific corporate announcements and market orders), so the findings in these studies are not necessarily inconsistent with the view that institutions are in general better informed than individual investors. 3 We do not examine information production by institutional investors, such as mutual funds, because the institutional (13F) and mutual fund holdings data, commonly used in institutional investor studies, provide only quarterly snapshots of institutions holdings and hence do not allow us to infer institutions trades at a relatively high frequency in a specific window. 1370 Downloaded from by guest on 06 May 2020 20:12 27/2/2020 RFS-OP-REVF190106.tex Page: 1371 13671411 Informing the Market Turning to sell-side analysts, we find evidence suggesting that both the amount and accuracy of information produced by sell-side analysts increase following the EDGAR implementation. Specifically, the number of analysts covering a firm increases and the forecast accuracy of analysts improves after the firm becomes subject to mandatory filing on EDGAR. In terms of economic magnitudes, the average firm experiences an increase of 0.223 analysts post-EDGAR, which is large considering that the mean and standard deviation of the number of analysts covering a firm are 2.489 and 3.922, respectively. Similarly, the average firm experiences an increase of 0.00138 in analysts forecast accuracy, representing 15.1% (1.7%) of the mean (standard deviation) of the variable. Perhaps more important, stock market responses to analysts revisions become significantly stronger after the firm becomes an EDGAR filer, suggesting that the market perceives analyst research as more informative. Th