Disclosure of outsourcing in the annual report: Causes and market returns effects

Firms increasingly are utilizing outsourcing to enhance or maintain their competitiveness. Prior research shows that capital markets value a firm's decision to outsource. This study uses a sample of firms announcing outsourcing arrangements in a press release to examine which factors are associated with the subsequent decision to voluntarily provide or withhold information about outsourcing in their annual report. The paper also examines whether annual report disclosure is a reliable signal of future market performance. We find that underperforming firms, larger firms, and firms experiencing negative outsourcing announcement market returns and negative long-term market returns are more likely to disclose outsourcing in their annual reports. There is also evidence that firms' disclosure of outsourcing in the annual report signals an improvement in market performance that is credible to the capital markets. We contend that the disclosure and subsequent firm performance issues we investigate apply to any type of outsourcing arrangement, and therefore our results are relevant to future information systems research on this subject. Our findings also suggest that regulatory standards could reduce private information search costs for investors by providing a common disclosure methodology for outsourcing activities.     

The new monetary and financial initiatives: Finance regaining its position as servant of the economy

Alternative financial and monetary innovations constantly multiply. Following major financial crises, propositions abound in an attempt to build new monetary and financial tools that break with conventional approaches; the aim is to “do differently.” Rather than official institutions, it is the general public – through the creation of communities – that takes charge of the issue, and thus initiatives fall within a bottom-up approach. But even more striking than the fact that this phenomenon is driven by economic actors is that all these initiatives – these financial innovations – reveal and even embody a real challenge to the conventional financial system, and directly criticize its functioning. Indeed, all are carriers of messages, values, etc. Curiously, most of the critics do stress the reality of finance and rehabilitate it in its economic and social role: that of being the servant of the economy.     

Board size and the variability of corporate performance

This study provides empirical evidence that firms with larger boards have lower variability of corporate performance. The results indicate that board size is negatively associated with the variability of monthly stock returns, annual accounting return on assets, Tobin's Q, accounting accruals, extraordinary items, analyst forecast inaccuracy, and R&D spending, the level of R&D expenditures, and the frequency of acquisition and restructuring activities. The results are consistent with the view that it takes more compromises for a larger board to reach consensus, and consequently, decisions of larger boards are less extreme, leading to less variable corporate performance.     

Do asset impairments and the associated disclosures resolve uncertainty about future returns and reduce information asymmetry?

The objective of this study is to provide insights into how Australian listed firms are implementing AASB 136 Impairments of Assets. Our first concern is whether uncertainty about future returns and information asymmetry motivates the recognition of asset impairments. We find no evidence that the recognition of asset impairments is associated with higher uncertainty about future returns. Furthermore, we find no evidence that the recognition of asset impairments is associated with higher information asymmetry. Our second concern is whether asset impairments and the associated disclosures provide information that reduces uncertainty about future returns and information asymmetry. While we find some evidence that asset impairments are associated with decreases in information asymmetry before the financial crisis, during the financial crisis, asset impairments are associated with increases in both measurement uncertainty and information asymmetry.     

Family friendly firms: does it pay to care?

In this paper we examine the returns to a portfolio of 29 firms that are perceived as family-oriented. The sample is based on firms awarded the best 100 companies for working mothers in Working Mother Magazine’s annual survey. There is much anecdotal evidence supporting the benefits of these programs, but little evidence relating family-oriented policies to shareholder wealth. We find, based on raw returns, that family-friendly firms do not earn statistically significant excess returns relative to a matched sample or to the S & P 500. Based on risk-adjusted returns, the family-friendly portfolio outperforms the market, but underperforms a matched sample portfolio.     

Demographic Change and Pharmaceuticals' Stock Returns

We analyse how demographic change affected profits and returns across pharmaceutical industries over the last 20 years. Fluctuations in different age group sizes influence the estimated demand changes for age‐sensitive drugs, such as antibacterials for young, antidepressants for middle‐aged, and antithrombotics for old people. These demand changes are predictable as soon as a specific age group is born. We use consumption and demographic data to forecast future consumption demand growth for drugs caused by demographic changes in the age structure. We find that long‐term forecast demand changes predict abnormal annual pharmaceutical stock returns for more than 60 firms over the time period from 1986 to 2008. An increase by one percentage point of annual demand growth due to demographic changes predicts an increase in abnormal yearly stock returns in the size of 3–5 percentage points. Short‐term forecast demand changes does predict negative abnormal stock returns for a time horizon below 5 years. A trading strategy taking advantage of the demographic information earns a significant abnormal return between 6 and 8 percentage points per year. Our results are consistent with the model by DellaVigna and Pollet (2007) , where investors are inattentive with extrapolation in the distant future and overreact to information in the near future.     

Explaining the accrual anomaly by market expectations of future returns and earnings

This study examines the accrual anomaly under the framework of the Campbell [Campbell, J.Y. (1991). A variance decomposition for stock returns. Economic Journal 101 (405), 157-179.] model. The Campbell (1991) model shows that realized asset returns are a joint function of 1) expected returns, 2) revisions in market expected future returns (i.e., return news), and 3) revisions in market expected future cash flows (i.e., cash flow news). The current study adopts the Easton [Easton, P. (2004). PE ratios, PEG ratios, and estimating the implied expected rate of return on equity capital. The Accounting Review 79 (1), 73-96.] model to estimate proxies for expected returns, return news, and cash flow news. The results show that firms with low accruals have lower expected returns than firms with high accruals, which is contradictory to prior research that argues that firms with low accruals are more risky. However, investors underestimate (overestimate) future earnings growth, a proxy for cash flow growth, for low (high) accrual firms. Further analysis demonstrates that earnings news (proxy for cash flow news) plays a major role in explaining abnormal returns associated with the accrual anomaly.     

Disclosure Practices by Family Firms: Evidence from Swedish Publicly Listed Firms

Abstract

I investigate the effect of family ownership on firms’ disclosure practices in their annual reports. In specific, I study Swedish publicly listed firms, which are typically characterized by controlling owners that have a strong influence in the corporate governance decisions of the firm, including corporate disclosures. To measure disclosure, I construct a comprehensive disclosure index covering information on (1) corporate governance, (2) strategic and financial targets and (3) notes to the financial statements. The results reveal that overall, family firms provide less disclosure in annual reports than non-family firms do. The finding is consistent with the premise that through their management positions, family owners can directly monitor managers and avoid costly public disclosures. Overall, the results suggest that ownership structure of firms is important to consider in understanding firms’ disclosure incentives, particularly in settings where controlling owners play a significant role in the governance of the firm.     

The moderating role of board gender diversity on the relationship between firm opacity and stock returns

In this study, we examine the impact of board gender diversity on the association between firm opacity and stock price crash. We utilize the negative shock of the 2007–2008 financial crisis to capital markets to examine whether firms with gender-diverse boards witnessed lower stock price crashes due to their lower opacity ex ante. Using a sample of S&P 1500 firms spanning the period 2005–2008, we employ a difference-in-differences research design and find that firms with high opacity ex ante witness more negative returns ex post. We also find that gender-diverse firms ex ante witness less negative returns ex post. Finally, our analysis reveals the moderating role that board gender diversity plays in the association between firm opacity and stock returns around the financial crisis. We subject our results to a range of robustness checks, including instrumental variable regressions, matched-sample analyses, and a set of falsification and placebo tests. Overall, we provide evidence that board gender diversity is associated with increased transparency in financial reporting, which pays off in times of crisis.     

Geographic earnings disclosure and trading volume

Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), Disclosures about Segments of an Enterprise and Related Information, most US multinational firms no longer disclose geographic earnings in their annual reports. Given the recent growth in foreign operations of US firms and the varying operating environments around the world, information (or lack thereof) related to geographical performance can affect investors’ information set. Using empirical tests that closely follow the [Kim, O., Verrecchia, R., 1997. Pre-announcement and event-period private information. Journal of Accounting and Economics 24, 395–419] model, we find results consistent with their predictions. Specifically, using a sample of firms with substantial foreign operations, we find evidence of a decrease in event period private information following adoption of SFAS 131 for firms that no longer disclose geographic earnings. These results suggest that decreased public information (i.e., non-disclosure of geographic earnings) reduces the ability of investors to utilize or generate private information in conjunction with the public announcement of quarterly earnings, which dampens trading. We also find evidence of a decrease in pre-announcement private information following adoption of SFAS 131. This is consistent with an overall improvement in public disclosures that has the effect of reducing differences in the precision of private information across investors in the period prior to the earnings announcement. However, such an effect is observed for both firms which no longer disclose geographic earnings and for firms that continue to disclose geographic earnings.     

The outsourcing of R&D through acquisitions in the pharmaceutical industry

We examine the performance of 160 pharmaceutical acquisitions from 1994 to 2001 and find evidence that on average acquirers realize significant positive returns. These returns are positively correlated with prior acquirer access to information about the research and development activities at target firms and a superior negotiating position. A unique Desperation Index is employed to determine the current status of a firm's internal productivity. We find that firms experiencing declines in internal productivity or which are more desperate are more likely to engage in an outsourcing-type acquisition in an effort to replenish their research pipelines.     

Loss firms’ annual report narratives and share price anticipation of earnings

We extend prior research into the association between disclosure quality and share price anticipation of earnings by discriminating between firms that report profits and firms that report losses. As a measure of disclosure quality we count the number of forward-looking earnings statements in annual report narratives. To measure the extent to which current share price movements anticipate future earnings changes we regress current stock returns on current and future earnings changes. The coefficients on the future earnings change variables are our measure of share price anticipation of earnings.Our regression results show that the association between annual report narratives and share price anticipation of earnings is not the same for profit and loss firms. For loss firms we find that the ability of stock returns to anticipate next period's earnings change is significantly greater when the firm provides a large number of earnings predictions in annual report narratives. We make no such observation for profit firms. In addition, once we control for variations in the intrinsic lead–lag relation between returns and earnings across industries, the observed difference between profit and loss firms becomes statistically significant. Overall, our results are consistent with annual report narratives being a particularly important source of information for loss-making firms.     

The effects of anticipated future investments on firm value: evidence from mergers and acquisitions

I examine the long-term valuation consequence of investment in mergers and acquisitions on acquiring firms through the “anticipation effect,” in which forward-looking prices embed investors’ expectations about the profitability of firms’ future acquisitions. Using a sample of firms with past acquisitions, I find that their market valuations depend on both the profitability of their past acquisitions and their current free cash flow. Among firms with positive free cash flow (when future acquisitions are likely), those with a worse history of value-destroying acquisitions experience lower market valuations. Among firms with negative free cash flow (when future acquisitions are less likely), firm value is not systematically related to acquisition history. These findings are consistent with investors forming expectations about the profitability of future acquisitions based on realized acquisition outcomes and valuing these firms based on their likelihood of making future acquisitions. They also provide support for using observed market prices as a proxy for investors’ expectations about future investment opportunities.     

Does Meeting Earnings Expectations Matter? Evidence from Analyst Forecast Revisions and Share Prices

This paper investigates whether the market rewards firms meeting current period earnings expectations, and whether any such reward reflects the implications of meeting expectations in the current period for future earnings or reflects a distinct market premium. We document that abnormal annual returns are significantly greater for firms meeting expectations, controlling for the information in the current year's earnings. We then test whether firms meeting expectations experience higher returns simply because their expected future earnings are also higher. We find firms meeting expectations have significantly higher earnings forecasts and realized earnings than firms that do not. We find that controlling for these higher future earnings, firms meeting expectations in one or two years do not receive a greater valuation than their fundamentals would suggest. We find, however, that the market assigns a higher value to firms that meet expectations consistently, controlling for an estimate of the firm's fundamental value.     

Stakeholder relations and stock returns: On errors in investors' expectations and learning

A significant number of institutional investors publicly state the belief that corporate stakeholder relations are associated with firm value in a manner that the financial market fails to understand. We investigate whether stakeholder information predicted risk-adjusted returns due to errors in investors' expectations and ultimately ceased to do so as attention for such information increased. We build a stakeholder-relations index (SI) for a wide range of U.S. firms over the period 1992–2009 and provide evidence that the SI explained errors in investors' expectations about firms' future earnings. The SI was positively associated with long-term risk-adjusted returns, earnings announcement returns, and errors in analysts' earnings forecasts over the period 1992–2004. However, as attention for stakeholder issues became more widespread, subsequently, these relationships diminished considerably. The results are consistent with the idea that increased investor attention for stakeholder issues eventually eliminates mispricing.     

How plain English use affects the length of annual reports: Evidence from the annual reports of foreign firms listed on the US stock exchange

This study examines the impacts of plain English on the length of annual reports for the sample of 20-F forms which are annually filed by foreign firms listed on NYSE and NASDAQ. We found out that foreign firms have better complied with plain English in their disclosures over time with shorter sentences, less jargon, and readable writing styles; however, there was a significant increase in the length of 20-F from 2004 to 2013. We also recognize the impacts of plain English on the length of annual reports are mixed. The issuers may completely improve the readability of annual reports without significantly increasing the length of annual reports if they sophisticatedly combine all four elements of plain English in their disclosures. Additionally, the usage of passive voice and jargon in firms’ disclosures negatively influences the liquidity of stocks. There are significant differences in behaviors of issuing annual reports among countries. After the financial crisis in 2009, annual reports become longer and less readable.     

The stock market valuation of human capital creation

We develop a measure of firm-year-specific human capital investment from publicly disclosed personnel expenses (PE) and examine the stock market valuation of this investment. Measuring the future value of PE (PEFV) based on the relation between lagged PE and current operating income, we first show that PEFV is positively associated with characteristics of human-capital-intensive firms. Next, we find that PEFV has a positive pricing coefficient, implying that the market recognizes some of its variation. In our main analysis, we find that market participants fail to fully impound the investment in human capital. The absolute value of analyst forecast errors is increasing in firm PEFV, and the signed value of these errors reveals that analysts are pessimistic for earnings of firms with high human capital investments. A long-short portfolio based on PEFV produces annualized value-weighted (equal-weighted) abnormal returns of 6.5% (3.5%). Portfolios formed by interacting PEFV with total PE, which combines the current potential investment in human capital with the historic portion of PE that created human capital, increase these returns to between 4.8% and 7.8%. These results are insensitive to numerous empirical choices.     

Lazy Prices

Using the complete history of regular quarterly and annual filings by U.S. corporations, we show that changes to the language and construction of financial reports have strong implications for firms’ future returns and operations. A portfolio that shorts “changers” and buys “nonchangers” earns up to 188 basis points per month in alpha (over 22% per year) in the future. Moreover, changes to 10-Ks predict future earnings, profitability, future news announcements, and even future firm-level bankruptcies. Unlike typical underreaction patterns, we find no announcement effect, suggesting that investors are inattentive to these simple changes across the universe of public firms.     

Does q-theory with investment frictions explain anomalies in the cross section of returns?

Q-theory predicts that investment frictions steepen the relation between expected returns and firm investment. Using financing constraints to proxy for investment frictions, we show only weak evidence that the investment-to-assets and asset growth effects in the cross section of returns are stronger in financially more constrained firms than in financially less constrained firms. There is no evidence that q-theory with investment frictions explains the investment growth, net stock issues, abnormal corporate investment, or net operating assets anomalies. Limits-to-arbitrage proxies dominate q-theory with investment frictions in explaining the magnitude of the investment-to-assets and asset growth anomalies in direct comparisons.