UNINTENDED CONSEQUENCES OF BRIGHT-LINE SIZE THRESHOLDS: EVIDENCE FROM SGX RULE 705(2)

Abstract

This paper documents an unintended consequence arising from the use of a regulatory 'bright-line' threshold that exempts small firms. An example of such a threshold is observed in SGX Rule 705(2), where under the rule, firms that have a market capitalisation at least S$75 million or higher on the last trading day of each calendar year have to issue quarterly reports. Using Rule 705(2) as a case study, I examine whether the S$75 million 'bright-line' threshold prescribed under the rule gives firms an incentive to behave opportunistically and manage their market capitalisation in order to remain below the threshold and avoid compliance. I present evidence on size management around the threshold, and show that this may be attributed to firms that have an incentive to avoid compliance. Additionally, I document several mechanisms that these firms may rely on to affect their market capitalisation. I find that they are more likely to issue cash dividends, and also take actions to exert temporary downward pressure on their share prices before the threshold testing date by accelerating bad news and delaying the disclosure of good news. Examination of any association between repurchases of shares and compliance avoidance however does not yield results. These findings highlight a potential pitfall in the use of 'bright-line' size thresholds in regulations. Where implicit or explicit firm size tests are used, some firms would have the incentive to remain below the threshold, and if they are allowed to circumvent regulatory compliance by taking advantage of the threshold, it signals poor regulatory design that authorities should be alerted to.