When Small Companies Dabble in Disinformation

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Companies may contract investor-relations’ firms (Promoters) to increase investor interest in their securities. These promoters do not disclose their association with the companies and issue positive recommendations. A review of such cases shows that the price of the firm increases for a short period of time. In all of these, the Securities and Exchange Commission (SEC) and National Association of Securities Dealers (NASD) have been taking legal action against the investor-relations’ firms, although only a handful of firms have actually been charged under Section 17(B) of the Securities Act 1934.

Event day (the day that these authorities started legal proceedings) returns for the hiring firms are negative and significant. In addition, the firm’s characteristics could help to identify the kind of firms that might hire these promoters. Indeed, smaller firms with free cash flow and higher capital expenditure are more likely to resort to such means. The managers of these firms are concerned about agency problems and try to increase disclosure to reduce the severity of this problem.

The advent of Internet has made the generation of information inexpensive and its distribution instantaneous. This fact has not been lost on managers: managers of new and small firms spent a lot of time and effort reaching out to the investing public. H. Hong and M. Huang (2005) conjecture that CEOs of these firms might spend as much as 25% of their time on investor relations. Using agencies that specialize in investor relations might reduce the cost of these activities and might enhance their effectiveness.

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