Informed trading on debt covenant violations: the long and short of it

We examine whether disclosure of complex information events reduces information asymmetry by investigating the long‐ and short‐term impact of firms' disclosure of debt covenant violations on the probability of informed trading. We argue debt covenant violation disclosures provide informed agents with a long window of opportunity to trade on their private information largely due to the uncertainty arising from the debt renegotiation process. We find the probability of informed trading is greater after the disclosure, particularly when the violation outcomes are unresolved or where there is concern about possible future violations.     

Corporate disclosure quality and institutional investors' holdings during market downturns1

We examine institutional investors' responses to corporate disclosure quality conditional on market states. Transient institutions react more positively to corporate disclosure quality during market downturns than during normal market periods, as better disclosure practices lower information asymmetry and are thus associated with reduced uncertainty, enhanced liquidity, and weakened impacts of crises, which are the most desirable features of assets during market downturns. Dedicated institutions are insensitive to corporate disclosure quality in both normal and market downturn periods, as they have access to inside information and rely less on public disclosures. Their reliance on corporate disclosures in market downturns, however, increases sharply after the implementation of Regulation Fair Disclosure, which removes their inside information advantage. We further show that corporate disclosure reduces information asymmetry to a greater extent in market downturns than in normal market periods and that transient ownership in market downturns provides strong price support and stabilizes return volatility, whereas dedicated ownership does not possess such functions. Finally, we show that the results are not simply driven by endogeneity and are robust to alternative corporate disclosure quality measure and to the control of other determinants of institutional holdings.     

Do measurement-related fair value disclosures affect information asymmetry?

Using a sample of European real estate firms over the 2007–2010 period, this study provides some evidence that measurement-related fair value disclosures reduce information asymmetry. We find a negative association between the extent of fair value disclosures and the bid-ask spread, but no association with two additional measures of information asymmetry (zero returns and price impact). Contrary to our expectation, we fail to find evidence that firms using model estimates exclusively benefit the most from such additional disclosure. Analysing measurement errors (the absolute difference between the selling price of an asset and its fair value prior to sale), we find that firms that use model estimates exclusively and provide more measurement-related disclosures have lower errors and more accurate fair value estimates. In other words, if our lack of results is due to investors not using this additional disclosure this is to their detriment.     

The Effectiveness of Regulation Fair Disclosure: Evidence from an Emerging Market

The effect of corporate disclosure in emerging markets is not clearly predictable because of the prevalent information leakage prior to disclosure. We empirically examine the effectiveness of Regulation Fair Disclosure (Reg FD) in reducing information asymmetry among equity traders in an emerging market. Specifically, we test whether fair disclosure activity is negatively related to the probability of informed trading (PIN). Multivariate tests on a sample of listed companies in Korea subject to Reg FD reveal the following: (1) more frequent disclosure under Reg FD is related to lower information asymmetry, and (2) this relation differs across the types of disclosure, with the effect of qualitative disclosures on the PIN being weaker than that of quantitative disclosures. Evidence also indicates that the negative association between fair disclosure activities and information asymmetry is more (less) pronounced for firms with poorer (better) information environments where selective information leakage is more (less) likely. The results are robust to sensitivity tests. Our findings have implications for disclosure regulations in emerging markets, given that the existing literature casts doubt on the effectiveness of corporate disclosure in such markets.     

Do Risk Disclosures Matter When It Counts? Evidence from the Swiss Franc Shock

We examine the relation between disclosure quality and information asymmetry among market participants following an exogenous shock to macroeconomic risk. In 2015, the Swiss National Bank abruptly announced that it would abandon the longstanding minimum euro‐Swiss franc exchange rate. We find evidence suggesting that firms with more transparent disclosures regarding their foreign exchange risk exposure ex ante exhibit significantly lower information asymmetry ex post. The information gap in bid‐ask spreads appears within 30 minutes of the announcement and persists for two weeks, during which new information gradually substitutes for past disclosures. We validate the information dynamics of past risk disclosures with three field surveys: (1) Sell‐side analysts emphasize the importance of existing (risk) disclosures in evaluating the translational and transactional effects of the currency shock. (2) Lending banks’ credit officers rely on past disclosures as the primary information source available for smaller (unlisted) firms in the immediate aftermath of the shock. (3) Investor‐relations managers use existing financial filings as a key resource when communicating with external stakeholders. The results suggest that historical disclosures help investors attenuate information asymmetry in light of unexpected news.     

Information Risk and Fair Values: An Examination of Equity Betas

Using a sample of U.S. financial institutions, we exploit recent mandatory disclosures of financial instruments designated as fair value level 1, 2, and 3 to test whether greater information risk in financial instrument fair values leads to higher cost of capital. We derive an empirical model allowing asset‐specific estimates of implied betas, and find evidence that firms with greater exposure to level 3 financial assets exhibit higher betas relative to those designated as level 1 or level 2. We further find that this difference in implied betas across fair value designations is more pronounced for firms with ex ante lower‐quality information environments: firms with lower analyst following, lower market capitalization, higher analyst forecast errors, or higher analyst forecast dispersion. Overall, the results are consistent with a higher cost of capital for more opaque financial assets, but also suggest that differences in firms' information environments can mitigate information risk across the fair value designations.     

The usefulness of firm risk disclosures under different firm riskiness,investor-interest,and market conditions: New evidence from Finland

To date, there is only meager research evidence on the usefulness of mandatory annual report risk disclosures to investors. Although it has been argued that corporate disclosure decreases information asymmetry between management and shareholders, we do not know whether investors benefit from high-quality risk reporting in a highly regulated risk disclosure environment. In this paper, we performed association tests to examine whether the quality of firms' mandatory risk disclosures relate to information asymmetry in the Finnish stock markets. In addition, we analyzed whether the usefulness of risk disclosures depends on contingency factors such as firm riskiness, investor interest, and market condition. We demonstrate that the quality of risk disclosure has a direct negative influence on information asymmetry. We also document that risk disclosures are more useful if they are provided by small firms, high tech firms, and firms with low analyst coverage. We also found that momentum in stock markets affects the relevance of firms' risk reports.     

Internal control quality and information asymmetry in the secondary loan market

We examine the association between disclosure of internal control deficiencies (ICDs) and information asymmetry (IA) in the US secondary loan market. We also investigate which types of ICDs intensify or mitigate conditions of information asymmetry in the same market. Relying on loan syndication, loan credit rating, financial debt covenants and loan size, we further explore the effect of loan specific characteristics on the association between ICDs and IA. Consistent with our predictions, we find that while ICDs increase information asymmetry in the secondary loan market, the inimitable characteristics in the secondary loan market (e.g., syndication, loan credit rating, financial covenants, and loan size) help to mitigate such negative consequences of the disclosure of ICDs on the firm’s informational environment. We further find that disclosures of ICDs for firms in regulated industries help to mitigate the negative consequences of ICDs disclosures on IA.     

Extreme Uncertainty and Forward‐looking Disclosure Properties

This study investigates the effect of extreme uncertainty on disclosure behaviour by analyzing the quality and quantity of forward‐looking disclosures during the global financial crisis and pre‐crisis periods, controlling for other determinants of disclosure behaviour. Prior research has struggled to distinguish between the quality and quantity dimensions of forward‐looking disclosures. Also, the impact of the recent financial crisis on these forward‐looking disclosure attributes has not yet been examined systematically. We address this gap by exploiting the unique setting of German publicly traded firms. These firms must provide forward‐looking information within their audited financial statements, although relevant regulation is sufficiently vague to allow great variation in the quality, scope and quantity of forward‐looking disclosures actually observed. Using hand‐collected data from 2005 to 2009, we provide evidence of a significantly negative association between crisis and disclosure quality. This finding is robust to several different disclosure quality proxies and regression specifications. In contrast, we find no negative significant relation between crisis and disclosure quantity; rather, there is evidence that reported volume increases during the crisis. Our results are consistent with extreme uncertainty, as occurring during times of crisis, negatively affecting the quality of voluntary disclosures, while firms maintain or increase disclosure quantity, ultimately diluting the information density of forward‐looking disclosures.     

Do higher value firms voluntarily disclose more information? Evidence from China

This paper examines the effect of guanxi on the relation between firm value and voluntary disclosure of information about new investment projects in China's institutional setting. We find a negative relation between firm value and voluntary disclosure for firms that rely heavily on guanxi in their value creation (e.g. non-high-tech firms, and firms located in regions with underdeveloped institutions). By contrast, for firms that rely less heavily on guanxi and more on other sources of core competencies (e.g. high-tech firms, and firms in high-marketisation regions), we find a positive relation between firm value and voluntary disclosure. The moderating role of guanxi on the relation between firm value and voluntary disclosure is explained by firms conscientiously balancing the costs and benefits of voluntary disclosure relative to guanxi. Specifically, high guanxi-dependence firms refrain from detailed voluntary disclosures for fear of revealing sensitive information that may harm their guanxi. In contrast, low guanxi-dependence firms rely more heavily on voluntary disclosures to reduce information asymmetry and financing cost, with such incentives being particularly strong for high value firms. Our evidence has implications for research on motives for disclosure and regulation of financial reporting.     

Cybersecurity Disclosure by the Companies on the S&P/TSX 60 Index

Cybersecurity has become a topic of great interest since 2010. Accounting issues surrounding cybersecurity governance, management, and disclosure have gained attention from accounting standard setters, large accounting firms, and professional associations, but only a limited number of studies have looked at cybersecurity disclosure. In this study, we examine whether the content of cybersecurity disclosures of Canadian firms comprising the S&P/TSX 60 index is aligned with best practices—that is, financial regulators' guidelines in that matter. A content analysis was performed of documents issued between January 2017 and mid‐2018, consisting of recent annual information forms (AIFs), annual and quarterly management's discussion and analysis (MD&As), proxy circulars, material change reports, and news releases. To assess the nature and extent of cybersecurity disclosure, we developed a scoring grid featuring 40 items based on financial regulators' guidelines. Results show that cybersecurity disclosure levels are low. Companies vary widely in the amount of detail they provide, and the information is often not company‐specific. The variations among industrial sectors involve the categories related to cybersecurity risk, cybersecurity risk mitigation, and other items. Most of the companies provided cybersecurity disclosures in the annual MD&A, and several reiterated some disclosure items in the AIF and proxy circular. The results of this study highlight some areas where cybersecurity disclosures have evolved and others where they could be improved. They suggest that some firms strive to avoid boilerplate language and be more company‐specific. The findings also suggest that financial regulators could issue more stringent requirements.     

Fair Value‐related Information in Analysts’ Decision Processes: Evidence from the Financial Crisis

We use a sample of conference calls and analyst research reports from international banks to examine how financial analysts request and communicate fair value‐related information in their valuation process. We find that analysts devote considerable attention to fair value‐related topics. Most of the conference call questions and references in research reports pertain to fair value reclassifications and fair value changes of liabilities resulting from banks’ own credit risk. The accounting impact of these one‐time effects during the financial crisis and a lack of corresponding firm disclosures help to explain the prevalence of these two topics. The content of the questions and references suggests that analysts have different motives for their interest in fair value‐related information. While some analysts adjust reported earnings for unrecognised fair value changes of reclassified assets, most of the observed analysts exclude banks’ own credit risk effects from reported earnings. Thus, the use of fair value‐related information varies substantially across analysts and across instruments.     

Ownership concentration, voluntary disclosures and information asymmetry in New Zealand

This paper investigates the impact of different classes of ownership concentration on information asymmetry conditional upon corporate voluntary disclosures in New Zealand. The current paper attempts to extend this stream of research by incorporating three mutually exclusive ownership structures and considering the interactive relationship between such ownership structures and corporate voluntary disclosures. Results reveal that ownership concentration in general is significantly positively associated with bid-ask spreads (proxy for information asymmetry) observed around annual report release dates. This finding supports the adverse selection hypothesis and importantly this effect is found to be most pronounced for financial institutions and management-controlled ownership categories. When voluntary disclosure is taken into account, the findings demonstrate that disclosures significantly attenuate information asymmetry risk associated with ownership concentration. This effect is particularly pronounced for firms with management-controlled ownership structures. The findings highlight the importance of corporate disclosures under concentrated ownership structures especially management-controlled ownership structures in reducing information asymmetry and enhancing market efficiency in New Zealand.     

Political/Policy Uncertainty,Corporate Disclosure,and Information Asymmetry*

Political/policy uncertainty causes significant disruption to capital markets around the world. This review synthesizes recent studies on this topic and provides suggestions for future research in this fast-growing area. Specifically, this review focuses on three areas of research: (i) the measurement of political/policy uncertainty, (ii) the impact of political/policy uncertainty on financial analysts' forecasts, and (iii) the impact of political/policy uncertainty on corporate disclosure. We find that political/policy uncertainty affects both corporate disclosures and financial analysts' forecasts and that these effects interact with information asymmetry in capital markets. Furthermore, we find that companies strategically change their disclosure practices during periods of heightened political/policy uncertainty.     

Voluntary Disclosure and Information Asymmetry: Evidence from the 2005 Securities Offering Reform

In 2005, the Securities and Exchange Commission enacted the Securities Offering Reform (Reform), which relaxes “gun‐jumping” restrictions, thereby allowing firms to more freely disclose information before equity offerings. We examine the effect of the Reform on voluntary disclosure behavior before equity offerings and the associated economic consequences. We find that firms provide significantly more preoffering disclosures after the Reform. Further, we find that these preoffering disclosures are associated with a decrease in information asymmetry and a reduction in the cost of raising equity capital. Our findings not only inform the debate on the market effect of the Reform, but also speak to the literature on the relation between voluntary disclosure and information asymmetry by examining the effect of quasi‐exogenous changes in voluntary disclosure on information asymmetry, and thus a firm's cost of capital.     

Market Efficiency, Bounded Rationality, and Supplemental Business Reporting Disclosures

The AICPA Special Committee on Financial Reporting has urged disclosure of relevant forward-looking information on risks and opportunities to supplement conventional financial statements. We conduct a laboratory market experiment to assess the effects of such disclosures on capital allocation decisions. We develop two sets of competing hypotheses regarding how capital markets react to supplemental disclosures. One set is based on the assumption of semi-strong market efficiency, while the other posits that the bounded rationality of individual traders leads to inefficient market prices. We find that explicit disclosure of management's best estimate of an uncertain quantity improves market efficiency, even though this disclosure is redundant with information in financial statements. Second, we find disclosure of an upper bound of management's estimate has the potential to bias security prices upward, while informationally equivalent disclosure of both upper and lower bounds removes this bias. These results suggest that experimental market reactions to these supplemental disclosures are inconsistent with market efficiency. Supplemental analyses of individuals' price predictions and trading behavior support our conclusion that inefficiencies are at least partially attributable to individual information processing biases.     

Information asymmetry and accounting disclosures for joint ventures

In September 1999, the Financial Accounting Foundation issued a special report recommending the use of the equity method supplemented with appropriate disclosures for corporate joint ventures in the United States. This study, using data for corporate joint ventures in Singapore, provides some preliminary evidence regarding the effect of the supplementary information disclosure on information asymmetry among market participants as measured by bid-ask spreads. The results show that the disclosure of supplementary information of joint ventures is associated with a significant decline in bid-ask spreads. The results also indicate that the decline in information asymmetry is larger when the investment in joint ventures is significant and that larger investing firms tend to have a smaller decline in information asymmetry compared to smaller investing firms. The implications of this study, that the provision of supplementary information about joint ventures could reduce information asymmetry among participants in equity markets, thus leveling the playing field among traders, could have implications for policymakers.     

Compliance with pension‐related mandatory disclosures and debt financing

Using hand‐collected data on the level of pension‐related mandatory disclosures required by International Accounting Standard 19 Employee Benefits, we test whether compliance levels with these disclosures convey information that affects firms’ access to the public instead of the private debt market, as well as the cost of their new debt issues. We document a higher tendency to access the public debt market for firms with higher levels of pension‐related disclosure. Furthermore, we find that firms with higher levels of pension‐related disclosure enjoy a lower cost in terms of issuance of public debt, but not a lower cost for private debt issues. Thus, the benefits of disclosure in reducing information risk are only realisable when creditors rely heavily on financial statements in their decision making, due to the limited access to private information. Additional tests reveal that high compliance levels effectively mitigate the negative effect of pension deficits on the cost of public debt. These findings provide novel evidence in the extant literature on the role of mandatory (and, in particular, pension‐related) disclosures on firms’ debt financing. They also have important policy implications.     

Market uncertainty and the importance of media coverage at earnings announcements

We investigate whether increased investor demand for financial information arising from higher market uncertainty leads to greater media coverage of earnings announcements. We also investigate whether greater coverage during times of higher uncertainty further destabilizes financial markets because of greater attention-based trading or, alternatively, improves trading and pricing by lowering investor acquisition and interpretation costs. When uncertainty is higher, we find evidence of greater media coverage of earnings announcements and that the greater coverage leads to improvements in investor informedness, information asymmetry, and intraperiod price timeliness, and greater trade by both retail and institutional investors. In contrast to the media serving an expanded role in improving capital markets during more uncertain times, we fail to find that changes in firm-initiated disclosures lead to similar improvements and find that less frequent analyst forecast revisions exacerbate problems in capital markets during earnings announcements.     

Factors Influencing Firms' Disclosures about Environmental Liabilities

This paper examines factors related to environmental liability disclosure decisions for firms in industries with substantial Superfund site involvement. We hypothesize that the extent of disclosure about environmental liabilities is associated with five factors: (1) regulation, including enforcement activity, (2) managements' information, including site uncertainty and allocation uncertainty, (3) litigation and negotiation concerns, (4) capital market concerns, and (5) other regulatory influence. Our empirical tests examine the association between measures of environmental liability disclosure, based on disclosures in firms' annual reports and Forms 10-K, and proxies for the five factors, based on information from other public sources, including the EPA. We find that all of our hypothesized factors except site uncertainty significantly influence firms' environmental disclosure decisions.