Simplifying Small Firm Disclosure

Michael Sykuta —  14 March 2014

An occasional reader brought to our attention a bill that is fast making its way through the U.S. House Committee on Financial Services. The Small Company Disclosure Simplification Act (H.R. 4167) would exempt emerging growth companies and companies with annual gross revenue less than $250 million from using the eXtensible Business Reporting Language (XBRL) structure data format currently required for SEC filings. This would effect roughly 60% of publicly listed companies in the U.S.

XBRL makes it possible to easily extract financial data from electronic SEC filings using automated computer programs. Opponents of the bill (most of whom seem to make their living using XBRL to sell information to investors or assisting filing companies comply with the XBRL requirement) argue the bill will create a caste system of filers, harm the small companies the bill is intended to help, and harm investors (for example, see here and here). On pretty much every count, the critics are wrong. Here’s a point-by-point explanation of why:

1) Small firms will be hurt because they will have reduced access to capital markets because their data will be less accessible. — FALSE
The bill doesn’t prohibit small firms from using XBRL, it merely gives them the option to use it or not. If in fact small companies believe they are (or would be) disadvantaged in the market, they can continue filing just as they have been for at least the last two years. For critics to turn around and argue that small companies may choose to not use XBRL simply points out the fallacy of their claim that companies would be disadvantaged. The bill would basically give business owners and management the freedom to decide whether it is in fact in the company’s best interest to use the XBRL format. Therefore, there’s no reason to believe small firms will be hurt as claimed.

Moreover, the information disclosed by firms is no different under the bill–only the format in which it exists. There is no less information available to investors, it just makes it little less convenient to extract–particularly for the information service companies whose computer systems rely on XBRL to gather they data they sell to investors. More on this momentarily.

2) The costs of the current requirement are not as large as the bill’s sponsors claims.–IRRELEVANT AT BEST
According to XBRL US, an XBRL industry trade group, the cost of compliance ranges from $2,000 for small firms up to $25,000–per filing (or $8K to $100K per year). XBRL US goes on to claim those costs are coming down. Regardless whether the actual costs are the “tens of thousands of dollars a year” that bill sponsor Rep. Robert Hurt (VA-5) claims, the point is there are costs that are not clearly justified by any benefits of the disclosure format.

Moreover, if costs are coming down as claimed, then small businesses will be more likely to voluntarily use XBRL. In fact, the ability of small companies to choose NOT to file using XBRL will put competitive pressure on filing compliance companies to reduce costs even further in order to attract business, rather than enjoying a captive market of companies that have no choice.

3) Investors will be harmed because they will lose access to small company data.–FALSE
As noted above,investors will have no less information under the bill–they simply won’t be able to use automated programs to extract the information from the filings. Moreover, even if there was less information available, information asymmetry has long been a part of financial markets and markets are quite capable of dealing with such information asymmetry effectively in how prices are determined by investors and market-makers.  Paul Healy and Krishna Palepu (2001) provide an overview of the literature that shows markets are not only capable, but have an established history, of dealing with differences in information disclosure among firms. If any investors stand to lose, it would be current investors in small companies whose stocks could conceivably decrease in value if the companies choose not to use XBRL. Could. Conceivably. But with no evidence to suggest they would, much less that the effects would be large. To the extent large block holders and institutional investors perceive a potential negative effect, those investors also have the ability to influence management’s decision on whether to take advantage of the proposed exemption or to keep filing with the XBRL format.

The other potential investor harm critics point to with alarm is the prospect that small companies would be more likely and better able to engage in fraudulent reporting because regulators will not be able to as easily monitor the reports. Just one problem: the bill specifically requires the SEC to assess “the benefits to the Commission in terms of improved ability to monitor securities markets” of having the XBRL requirement. That will require the SEC to actively engage in monitoring both XBRL and non-XBRL filings in order to make that determination. So the threat of rampant fraud seems a tad bit overblown…certainly not what one critic described as “a massive regulatory loophole that a fraudulent company could drive an Enron-sized truck through.”

In the end, the bill before Congress would do nothing to change the kind of information that is made available to investors. It would create a more competitive market for companies who do choose to file using the XBRL structured data format, likely reducing the costs of that information format not only for small companies, but also for the larger companies that would still be required to use XBRL. By allowing smaller companies the freedom to choose what technical format to use in disclosing their data, the cost of compliance for all companies can be reduced. And that’s good for investors, capital formation, and the global competitiveness of US-based stock exchanges.

7 responses to Simplifying Small Firm Disclosure

  1. 
    northfork investor 15 March 2014 at 5:10 am

    Many many investors rely on xbrl data formatting to efficiently compare financial data across issuers. This bill is very insensitive to that efficiency. It would send me back to the stone age. Many small issuers would choose not to file in xbrl format and create many analytical problems.

    • 
      Michael Sykuta 15 March 2014 at 9:09 am

      True, many investors do use it. Even the research center I run uses it. But that doesn’t mean forcing firms to use it is good policy. If in fact, investors stop paying as much attention to firms that don’t disclose using XBRL, bid-ask spreads will increase/liquidity will decrease in those shares. Volumes traded may go down. Investors can adjust for that and issuers can decide whether that’s what they want for their shares.

      • 
        northfork investor 16 March 2014 at 9:14 am

        it is not truthful to say the bill won’t change the information available to investors once you add efficiency and accessibility dimension to it. if your point is to compare XBRL costs for these limited number of small firms to the many more investors’ costs of not having XBRL efficiency (which it is not) then that has some validity.

  2. 

    Nice to have a pulpit to preach from. Are you an investor? No company on earth wants to disclose anything and the legalese in a 60 page annual report is useless.

    Have you ever used the SEC website?
    It’s a joke.

    So you think it is ok that investors are forced to bear the costs by paying for research reports? Companies like E*trade and yahoo finance are not non-profits. They CHARGE for those products and make a pretty penny. Millions in revenue. But you are ok with that?

    And since when is $250,000,000 in revenue a small company?

    From an investor protection point of view, H.R. 4164 is not a Small Company disclosure Simplification Act, it is a clear handout to a politician’s contributors.

    • 
      Michael Sykuta 15 March 2014 at 9:33 am

      The nice (and not-so-nice) thing about the Internet is that anyone can create a pulpit to preach from and let the blogosphere decide whether it influences discussion.

      Not only have I used the SEC website, my research center has been extracting data from EDGAR since EDGAR came into being. If you think it’s bad now, you should have seen it in 1996. I also spend extensive time sorting through annual reports to get the details that even EDGAR doesn’t provide easily. And I force students to do that as well in conducting valuation forecasts. So I think I’m pretty familiar with what we’re talking about. And yes, I’m also an investor. It’s not like I can trust Social Security to bail me out in 20-25 years.

      Companies that sell XBRL compliance services are also for-profit companies, as are many firms (aside from E*trade and Yahoo! Finance) that extract financial information from the filings and make it more available to investors even now. Yes, I’m ok with investors having to pay the cost of research–and more importantly, I’m ok with letting businesses decide whether they want to make it easier for people to extract their financials by using XBRL (see my response to norfolk above).

      I agree that $250 Million in annual gross revenue isn’t small by many people’s conception. The fact that it allegedly covers 60% of firms would seem to support that. But then, I suppose the real question for the bill’s sponsors is why not just exempt everyone from the mandate?

  3. 

    First of all voluntary reporting is the most rediculous thing anyone can possibly think of for public issuers in the small, nano, and micro cap space. Go look into the pink sheets (otcqb) market place it is quite literally the Wild Wild West.

    Second of all your missing one of the major functions of Xbrl and that is the long term sustainability of the US securities industry. XBRL is at its core a way to gather data over time when the rest of the world gathers the next 19 years of financial information and those market places have transparency through algorithms not yet found then we will be left sucking hind tit. The dominance of the us securities market has everything to do with extreme transparancy.

    Public companies should be glass houses. Removing reporting requiremts hurts every investor from large institutions to grandma Judith’s etrade purchases.

    Publishing garbage like this makes me sick. You should be ashamed of yourself.

    • 
      Michael Sykuta 15 March 2014 at 9:18 am

      James, perhaps you should spend the 2 minutes it takes to read the (amended version of the) bill. It’s linked at the top of the article. First, there is no change in reporting requirements, just the format those reports are in. Second, the bill requires the SEC to study how international exchanges handle data disclosure requirements as part of the study of how the exemption and/or use of XBRL would affect domestic vs. international exchanges. And the exemption is (currently) for no more than 5 years, not 19. And oddly enough, we have all this data going back for decades before XBRL was even created (before the Internet was even created), so it’s a bit naive to think the US securities industry is going to suddenly be devoid of data and data collection.

      Finally, history has pretty consistently shown that regulations that require specific technologies rather than specific outcomes tend to end up choosing bad technologies. If XBRL is as the best format for structuring data reports, it will continue to be used and will come to dominate the market. The fact that larger firms still have to use XBRL already gives it a leg up against other possible data formatting structures that may be easier for issuers and investors to use.

      If publishing garbage such as your post makes you sick, I suggest you stop doing it.