The Twilight Zone: OTC Regulatory Regimes and Market Quality

The Twilight Zone: OTC Regulatory Regimes and Market Quality

Ulf Brüggemann, Aditya Kaul, Christian Leuz, Ingrid Werner

Series number :

Serial Number: 
224/2013

Date posted :

August 01 2013

Last revised :

September 04 2013
SSRN Share

Keywords

  • securities regulation • 
  • Disclosure • 
  • liquidity • 
  • Blue Sky Laws • 
  • Price Efficiency • 
  • Pink Sheets • 
  • OTC Bulletin Board • 
  • JOBS Act

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.

Authors

Real name: 
Ulf Brüggemann
Real name: 
Aditya Kaul
Fellow, Research Member
The University of Chicago - Booth School of Business
Real name: 
Ingrid Werner