Liability for Non-Disclosure in Equity Financing

Liability for Non-Disclosure in Equity Financing

Albert H. Choi, Kathryn E. Spier

Series number :

Serial Number: 

Date posted :

February 07 2023

Last revised :

February 07 2023
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  • Equity Financing • 
  • IPO Liability • 
  • Non-Disclosure • 
  • securities litigation • 
  • Liability Waiver • 
  • Class Action Waiver

This paper analyzes the effects of holding firms liable for non-disclosure of material information when raising capital. A privately-informed entrepreneur may choose to withhold material information from prospective investors. After cash flows are realized, investors may sue the firm ex post for the entrepreneur's (alleged) non-disclosure.

Any damages award received by investors is partially offset by the reduced value of their equity stake. Absent liability, entrepreneurs have an excessive incentive to withhold bad news and pursue socially-wasteful projects. Liability for non-disclosure deters the entrepreneur and prevents misallocation of capital. The socially-optimal damage award may be supra-compensatory, exceeding the overcharge paid by the investors. Depending on the likelihood of court error and litigation cost (including the rent captured by lawyers), socially optimal liability may be either zero or the minimum necessary for full deterrence. After presenting the basic results, liability waivers and empirical implications are also discussed.


Real name:
Kathryn E. Spier