Courtesy of Stephen Glaeser, Bryce Schonberger, Charles E. Wasley, and Jason Xiao
Theoretical models explore when and why individuals incur costs to acquire information about a firm that is not publicly available (often referred to as private information acquisition). Empirical evidence of these theories’ implications is virtually non-existent due to the difficulty of observing private information acquisition. In our article, we use Freedom of Information Act (FOIA) requests submitted to the U.S. Securities and Exchange Commission (SEC) to overcome this difficulty and test the implications of these theories. We find that the perception of information asymmetry between managers and outsiders resulting from proprietary costs or agency considerations triggers costly information acquisition. We also find that private information acquisition via FOIA requests is associated with changes in the competitive landscape and lawsuit filings.
Background Information
We regard FOIA search as a form of “private” information acquisition. Unlike public information search, FOIA search is costly on the margin because requesters must pay a fee (an explicit cost), and because FOIA requests are fulfilled after a considerable and highly variable delay (an implicit cost). Given these features, FOIA search is unlikely to be motivated by a desire to respond to events where price discovery occurs rapidly (e.g., earnings announcements). Conceptually, information search takes place along a continuum, with search of readily-available public information at one end, and actions taken to uncover private information at the other end. We take the perspective that the costs associated with FOIA search offer a unique setting to explore the acquisition of information that is closer to the private end of the continuum (which we know comparatively less about).
Since FOIA search has not been widely studied to date, we begin by providing descriptive evidence on the use of FOIA search over time and the frequency with which FOIA searches target specific industries. We find that FOIA search generally increases over time, reaching a peak in 2015. FOIA search is more likely to target firms in the healthcare sector and less likely to target firms in the finance sector. Given the availability of substantial regulatory and public information for financial firms, the lower incidence of FOIA search for the financial sector points to some evidence that high-quality public information substitutes for FOIA search.
We draw on Bens et al. (2011) to identify two theoretical sources of information asymmetry that we expect to elicit costly search via the FOIA process. These sources are driven by managers’ motives to withhold information, namely, proprietary costs and agency-related concerns. Proprietary costs lead managers to withhold information to prevent the revelation of proprietary information to competitors, prompting search by competitors for potentially valuable information. Agency-related concerns lead managers to withhold information that would reflect poorly on their managerial ability or performance, prompting search by stakeholders interested in monitoring and evaluating managers.
Findings
We use proxies for agency-related and proprietary incentives for managers to withhold information that should stimulate costly search as determinants in models of FOIA search. In particular, we study situations with greater scope for private information of a proprietary nature, such as when the firm has greater growth opportunities or investments in intangible assets via research and development (R&D) and trade secrets, and/or of an agency-related nature, such as when managers engage in insider trading. We find that the perception that managers may have private information due to agency and/or proprietary costs incentives triggers FOIA search. In addition, consistent with the differential costs and benefits of FOIA search compared to public information search, we find the determinants differ between the two types of information search. Specifically, FOIA requests target firms with more investments in intangible assets and growth firms, whereas public information searches, measured as search using the SEC’s EDGAR system, target firms with fewer investments in intangibles and value firms.
While our determinants models point to the importance of both proprietary and agency-related motivations for triggering FOIA search, it is unclear whether the information uncovered by FOIA search is useful. To shed light on the ex-post value of FOIA search, we investigate the types of requests that are associated with proprietary- and agency-related real outcomes. If FOIA search is designed to uncover previously unknown information about firms regarding proprietary and/or agency-related costs, then FOIA search should be associated with outcomes that are consistent with elevated proprietary and agency-related costs. We examine two outcomes pertaining to elevated agency costs: disclosure-related securities class action lawsuits and chief executive officer (CEO) turnover. We also examine two outcomes pertaining to elevated proprietary costs: the likelihood of patent-related lawsuits and product market fluidity.
We further perform tests that distinguish between types of requesting organizations and their incentives or rationales for conducting FOIA search. A key feature of the FOIA process is that the SEC requires requesters to identify their affiliations. We use these affiliations to perform tests designed to differentiate the incentives for FOIA search across requesters. We find that almost 90% of FOIA search is conducted by law firms, hedge funds, media outlets, and intellectual property consultants.
An examination of these organizations’ websites and business descriptions reveals that some of these organizations use FOIA search almost exclusively to uncover ongoing, undisclosed SEC investigations. These organizations rely on denials of their requests by the SEC’s Office of FOIA Services, in the form of b7A exemptions, as indicators that the SEC is investigating the firm targeted by their search. Because these requesters focus on “probing” for SEC investigations, we separate their FOIA searches (referred to as Probes search) from the other FOIA search activities (Non-Probes search). We document significant differences in the determinants of Probes and Non-Probes FOIA search. In particular, we find that while Probes FOIA search tends to cluster in larger firms, where the benefits of monitoring the firm for undisclosed SEC investigations are presumably larger, Non-Probes FOIA search tends to be evenly distributed across quintiles of firm size.
The distinction between search types becomes even more prominent when we relate FOIA searches to ex-post firm outcomes. Specifically, we find that Non-Probes FOIA search is associated with increases in patent lawsuits, product market competition, and securities class action lawsuits. These results suggest that FOIA requesters will only bear the costs to acquire private information via FOIA search when there are benefits to be gained from that information.
In terms of the ability of Probes FOIA searches to predict future outcomes, we find that Probes searches precede increases in patent lawsuits but are unassociated with changes in product market competition and filings of securities class action lawsuits. The latter finding suggests that Probes requesters fail to target firms that are ex ante more likely to be subject to SEC investigation, pointing to a limitation of Probes search for uncovering SEC investigations. Since Probes requesters rely on denials of their requests to identify firms currently being investigated, we also examine whether FOIA office responses that claim a b7A exemption themselves predict future securities class action lawsuit filings. We find that FOIA requests that elicit a b7A exemption are associated with elevated class action lawsuit filings, consistent with Probes requesters’ likely objective in filing the request. In addition, we find some evidence of higher CEO turnover in periods with greater Probes search, consistent with an agency-related motivation for this type of FOIA search.
Conclusion
Our study explores when and why individuals may incur a cost to acquire information about a firm that is not publicly available. Using SEC FOIA searches to circumvent data availability issues, we find that demand is greatest when the benefits to understanding and contextualizing insiders’ information advantage are the largest, such as when there is greater investment in R&D, more insider trading, or more trade secret mentions in the 10-K. We also provide insight into the use of SEC filings for competitive and stewardship purposes by documenting evidence that FOIA search is significantly associated with firm-level litigation and competition. Moreover, variation in our findings across requesters highlights the importance of distinguishing between the different types of incentives to engage in FOIA search.
