The information content of SEC accounting series release no. 190

The study examines the security price behavior of firms at the time of three events: the proposal of the SEC's accounting series release (ASR 190) to require replacement cost disclosures, the adoption of ASR 190, and the initial filing of the data with the SEC. The primary analysis focuses upon differential security return behavior among reporting firms. Several extensions, including a comparison with nonreporting firms, are also conducted. The basic findings indicates no security price effects and is consistent with the hypothesis that no information was provided to the market during the three time intervals studied. Alternatively, the inability to find an effect may be due to a misspecification in the research design. However, the basic finding is robust under several additional analyses and specifications.     

ASSET PRICING AND FINANCIAL REPORTING WITH CHANGING PRICES

This study empirically investigates the recent SFAS No. 33 requirements to determine if the inflation disclosures, or information similar to it, are impounded in security returns. An attempt is also made to determine which of the two diverse disclosures best represent the information impomded by the market. The investigation utilizes a methodological framework arising out of currently accepted asset pricing theory. The results suggest that the current cost data parallels the information impounded in security returns and that it provides risk information not included in the commonly employed systematic risk factor, beta.     

Barriers to Interpretation—A Case Study of Philips Electronics NV

Philips Electronics NV, a very large European company, went through considerable upheaval in the period 1980 to 1994. Accounting disclosures did not seem to be very helpful to statement readers who wanted to evaluate Philips' progress and position. The company's financial condition and income results deteriorated significantly during most of the period, and large losses were shown in 1990 and 1992. Prior to the huge loss recorded in 1990, there were few indications in the annual reports that troubles were mounting. In earlier periods a series of accounting changes were made, the effect of which typically was to increase income. The most significant change came in 1992, when Philips abandoned current cost accounting. We investigated financial analysts' reactions to company disclosures and found that they had problems interpreting the effects of Philips' accounting changes. In addition to accounting changes, Philips also used a somewhat arbitrary restructuring charge (or credit) to adjust income amounts. Finally, the absence of full explanations from the directors at some points could have resulted in users of the annual report being misled. Over the period studied, Philips lost a significant portion of its stockholders' equity. The effect of its reporting practices was to obscure the impact of the unfavorable economic events that affected the company. Financial reporting, at least for this company, fell short of providing disclosures that told a clear story of what was taking place. In the periods before large losses were recorded, few hints were provided of impending disasters. Overall, the results of this study are disturbing. Although the study is restricted to one company, the results deserve the thoughtful consideration of both academics and practising accountants.     

Market reaction to the 1976 replacement cost disclosures

A variety of tests are conducted to determine whether replacement cost disclosures as mandated by the Securities and Exchange Commission's Accounting Series Release 190 provided information to capital market agents. In particular, the fiscal year 1976 disclosures made in early 1977 are examined. Information content is assessed by observing distributions of rates of return on common stocks. These distributions are estimated using both time series and cross-sectional data. No evidence of information content is found.     

The adjustment of security returns to the disclosure of replacement cost accounting information

In March 1976, the Securities and Exchange Commission (SEC) promulgated Accounting Series Release No. 190 (ASR 190) requiring the disclosure of certain replacement cost (RC) accounting data by its registrants. The purpose of this study is to assess whether the RC disclosure rule had any effect on common stock returns for firms affected by the new rule. Distinguishing the effect of compliance costs from the effect of information in the RC data, we found no sign of a cost effect and no strong evidence of an information effect. This result appears to imply (a) that the burden of the ASR 190 compliance costs was not large enough to induce downward adjustments of the firms' security returns; and (b) that the RC data did not provide new information useful to investors as asserted by the SEC.     

The incremental information content of replacement cost earnings

The study explores the incremental explanatory power of replacement cost earnings variables (derived from ASR 190 data) with respect to explaining cross sectional differences in security returns. As such, the study is a natural extension of previous research, including analyses of the effect of security returns of ASR 190 data at the time of disclosure, investigations of cross sectional relationships between security returns and historical cost earnings, and studies of multiple signals. The basic finding is that pre-holding gain net income provides no incremental explanatory powerm given knowledge of historical cost earnings. However, the converse does not hold. Taken together, the findings are consistent with the contention that pre-holding gain net income is a garbled version of historical cost earnings. The basic finding is robust under several extensions of the initial research design. The research design incorporates a two-stage approach which permits a determination of the incremental explanatory power of collinear variables. The findings are in contrast to those of a previous study by Easman et al. (1979). The nature of the difference in research design inducing the difference is identified. Potential reasons for the difference in findings are provided.     

The impact of replacement cost disclosure on security prices: New Evidence

A number of studies have tested for information content in the ASR 190 disclosure by comparing the conditional and unconditional distribution of abnormal security returns around the time of disclosure. Since no differences were observed, it was concluded that ASR 190 had no information content. The study reported below performs a similar test by estimating the regression function of the conditional distribution of abnormal returns. This test procedure controls for the information content in contemporaneous historical cost disclosure and uses a conditioning variable not considered in earlier tests. It finds statistically significant stock price effects. However, because most of the effects appear to precede the official announcement date by several months, it is unclear whether stock prices were responding to the leakage of the information content of ASR 190 prior to disclosure, to private production of information contained in ASR 190 or to a variable omitted from the study which happens to be correlated with replacement costs.     

The relevance of environmental disclosures: Are such disclosures incrementally informative?

Establishing the information content of transparent voluntary environmental disclosures and the source of this information content is of fundamental importance for corporate social responsibility (CSR) practitioners. Our results indicate that: (1) incremental to information provided by current Toxics Releases Inventory (TRI) data, voluntary environmental disclosures provide valuation relevant information; (2) the various disclosure categories are similar in value relevance, implying that each category is informative of management’s current environmental strategies; (3) current TRI is positively associated with cost of capital but there is no association between voluntary environmental disclosures and cost of capital; and (4) taken together, the above results point to a signaling role for such disclosures and financial performance prediction as the means by which voluntary environmental disclosures enhance firm value. This advances the literature by pinning down the source of firm value enhancement of such disclosures. Our results suggest that a proactive environmental strategy and the signaling of such a strategy to investors can enhance a firm’s stock price, a finding which will assist CSR practitioners in convincing top management that proactive environmental strategies combined with transparent voluntary environmental disclosures are worthwhile.     

Risk reporting: A study of risk disclosures in the annual reports of UK companies

The concepts of risk and risk management have received considerable attention lately, but this has yet to be reflected in empirical research examining firms’ risk reporting practices. This study seeks to address this gap in the literature and explores risk disclosures within a sample of 79 UK company annual reports using content analysis. A significant association is found between the number of risk disclosures and company size. Similarly a significant association is found between the number of risk disclosures and level of environmental risk as measured by Innovest EcoValue`21™ Ratings. However, no association is found between the number of risk disclosures and five other measures of risk: gearing ratio, asset cover, quiscore, book to market value of equity and beta factor. The paper also discusses the nature of the risk disclosures made by the sample companies specifically examining their time orientation, whether they are monetarily quantified and if good or bad risk news is disclosed. It was uncommon to find monetary assessments of risk information, but companies did exhibit a willingness to disclose forward-looking risk information. Overall the dominance of statements of general risk management policy and a lack of coherence in the risk narratives implies that a risk information gap exists and consequently stakeholders are unable to adequately assess the risk profile of a company.     

Risk disclosure and cost of equity: The Spanish case

In this paper we make an empirical study of the relationship between risk disclosure and the cost of equity. In particular, the objective being pursued is to contrast whether or not the cost of equity for the company is related to its financial and non-financial risk disclosure. Our results show no statistically significant relationship between the latter and the cost of equity; and a statistically significant relationship, with a positive sign, between this cost and financial risk disclosure. This suggests that company risk disclosures appear to introduce unknown contingencies and risk factors rather than only update information about known risks.     

Improving the relevance of risk factor disclosure in corporate annual reports

This research develops a model for assessing the quality of risk disclosures and applies the proposed model to four companies in the food production and processing sector. We contribute to the literature by extending prior work on risk disclosure quality using a longitudinal approach to assess the quality of risk reporting. While previous studies have described disclosure practices, this paper adopts a normative approach to disclosure. By suggesting a way of improving risk reporting disclosures, the paper provides guidance for current and future company managers. In line with previous research, this paper identifies certain problems with existing risk disclosures. Results suggest that company managers prefer providing disclosures that are symbolic rather than substantive. We argue that institutional factors and proprietary costs contribute towards and can explain this behaviour. In suggesting a way forward we highlight the role that stakeholders including managers, users, regulators and auditors can play in improving the quality of risk reporting. Flexibility in reporting could be maintained by adopting a properly monitored ‘comply or explain’ approach.     

Textual risk disclosures and investors’ risk perceptions

We examine the association between changes in companies’ textual risk disclosures in 10-K filings and changes in stock market and analyst activity around the filings. We find that annual increases in risk disclosures are associated with increased stock return volatility and trading volume around and after the filings. Increases in risk disclosures are also associated with more dispersed forecast revisions around the filings. In contrast to prior literature documenting resolved uncertainties in response to various types of company disclosures, our findings suggest that textual risk disclosures increase investors’ risk perceptions. However, the results are less pronounced for firm-level disclosures that deviate from those of other companies in the same industry and year. These results lend support for critics’ arguments that firm-level risk disclosures are more likely to be boilerplate.     

Change You Can Believe In? Hedge Fund Data Revisions

We analyze the reliability of voluntary disclosures of financial information, focusing on widely‐employed publicly‐available hedge fund databases. Tracking changes to statements of historical performance recorded between 2007 and 2011, we find that historical returns are routinely revised. These revisions are not merely random or corrections of earlier mistakes; they are partly forecastable by fund characteristics. Funds that revise their performance histories significantly and predictably underperform those that have never revised, suggesting that unreliable disclosures constitute a valuable source of information for investors. These results speak to current debates about mandatory disclosures by financial institutions to market regulators.     

The Role of Risk Management and Governance in Determining Audit Demand

Abstract:  Most prior research into audit fees has been based on a theoretical model which treats audit fees as the by-product of a production function ignoring potential demand forces that may drive the level of the audit fee. Inspired by prior 'anomalous' results, we take a different perspective by focusing on demand factors that may affect the level of the audit fee. Using data collected from a sample of listed companies in Belgium, we consider both disclosures about risk and risk management and actual decisions about corporate governance to examine whether audit fees are higher when these demand forces exist. In general, we expect that external auditing will increase in situations where there are multiple stakeholders with individual risk profiles who can shift some of the cost of monitoring to other stakeholders. Consistent with our theory and expectations, our results indicate that audit fees are higher when a company has an audit committee, discloses a relatively high level of financial risk management, and has a larger proportion of independent Board Members. Audit fees are lower when a company discloses a relatively high level of compliance risk management. The latter result indicates that controls are only complementary as long as they are voluntary, as mandated controls act as substitutes for non-mandated controls.     

Disagreement and the Cost of Capital

We assess how forms of disagreement among investors affect a firm's cost of capital. Firms experience a lower cost of capital if investors perceive that other investors are ignoring relevant disclosures (perceived errors of omission), but a higher cost of capital if investors perceive that others are responding to irrelevant disclosures (perceived errors of commission). The impact of these two sources of disagreement on the cost of capital is determined by the distribution of opinion and the nature of disclosure. For example, even though aggregated disclosures reveal less to investors, aggregated disclosures may decrease the cost of capital by eliminating disagreement associated with perceived errors of commission. These and additional results arise because the cost of capital is driven not only by investors’ uncertainty about the firm's future earnings performance, but also by investors’ uncertainty about the evolution of beliefs, which partly determines the path of prices.     

Rhetoric, argument and impression management in hostile takeover defence documents

This exploratory study extends the analysis of narrative disclosures from routine reporting contexts such as annual reports and press releases to non-routine takeover documents where the financial consequences of narrative disclosures can be substantial. Rhetoric and argument in the form of impression management techniques in narrative disclosures are examined. Prior thematic content analysis methods for analysing good and bad news disclosures are adapted to the attacking and defensive themes in the defence documents of target companies subject to hostile takeover bids. The paper examines the incidence, extent and implications of impression management in ten hostile takeover defence documents issued by target companies listed on the London Stock Exchange between 1 January 2006 and 30 June 2008. Three impression management strategies – thematic, visual and rhetorical manipulation – are investigated using content analysis methodologies. The findings of the research indicate that thematic, visual and rhetorical manipulation is evident in hostile takeover defence documents. Attacking and defensive sentences were found to comprise the majority of the defence documents analysed. Such sentences exhibited varying degrees of visual and rhetorical emphasis, which served to award greater or lesser degrees of prominence to the information conveyed by target company management.While exploratory in nature, this paper concludes with suggestions for future more systematic research allowing for greater generalisations from the findings.     

The impact of tagging qualitative financial information on investor decision making: Implications for XBRL

This study extends prior research by investigating whether investors benefit from tagging complex narrative disclosures. We examine how tagging facilitates professional and nonprofessional investors' acquisition and assimilation of narrative disclosures in assessing company risk and predicting future performance. Participants were randomly assigned to a standard or tagged presentation of Management's Discussion and Analysis (MD&A), the U.S. equivalent to Management's Commentary. The two versions contain identical overall information. The standard version works similar to a PDF file where the user can access sections of the MD&A by selecting titled sections. The tagged version uses an extended hierarchical structure proposed for the MD&A and as a conceptual foundation for developing a related XBRL taxonomy. As theorized, results indicate that nonprofessional investors use a more directive search strategy under the tagged condition while professional investors' search strategies are unaffected by the tagged condition. Saliency of risk information increases for both investor groups in the tagged condition (i.e., risk assessments and stock price predictions are more associated). Our findings have important implications in light of the U.S. SEC's decision to preclude inclusion of XBRL-tagged MD&A information in mandatory filings due to taxonomy limitations.     

The predictive ability of entity-wide geographic sales disclosures: IAS 14R versus IFRS 8

This report examines the predictive value of geographic revenue disclosures under IFRS 8 in forecasting company revenues using four forecast models. The findings show that the predictive accuracy of IFRS 8 entity-wide geographic sales significantly outperform consolidated sales in forecasting consolidated sales one year out. The results indicate that the predictive ability of country specific entity wide geographic sales improves on average by six percent when geographic sales are reported for country of domicile or by each individually material country. The study also finds that geographic sales disclosures by companies located in countries with high and moderate enforcement regimes improve the predictive accuracy of geographic sales by five percent. These results provide evidence that the disclosure of finer geographic sales data is more decision useful and associated with improved predictive accuracy for large listed companies in Europe, Australia and New Zealand.