Information Disclosure Strategy

Skinner D. , “Why Firms ‘Voluntarily’ Disclose Bad News,” working paper, University of Michigan, March 1992.

For example, Spence M. , “Job Market Signaling,” Quarterly Journal of Economics (August 1973), pp. 355–74; Ross S. , “The Determination of Financial Structure: The Incentive-Signaling Approach,” Bell Journal of Economics (Spring 1977), pp. 23–40; Porter M. , Competitive Strategy (New York, NY: The Free Press, 1980) and Competitive Advantage (New York, NY: The Free Press, 1985).

Woolridge R. , “Competitive Decline and Corporate Restructuring: Is a Myopic Stock Market to Blame?” Journal of Applied Corporate Finance (Spring 1988), pp. 26–36. Investors' reaction to these strategy announcements was measured by the two-day (the day prior to and the day of the announcement) “market-adjusted” stock price change. The market-adjusted price change, or abnormal stock return, is the stock's percentage price change (including dividends) minus the corresponding change of a broad market index (e.g., the S&P 500).

Significant investors' response to capital expenditure and R&D announcements were also documented by: McConnel J. Muscarella C. , “Corporate Capital Expenditure Decisions and the Market Value of the Firm,” Journal of Political Economics (July 1985), pp. 399–422; Jarrell G. Lehn K. Marr W. , “Institutional Ownership, Tender Offers, and Long-Term Investments,” The Office of the Chief Economist, Securities and Exchange Commission, April 1985; and Lev B. Thiagarajan R. , “Fundamental Information Analysis,” working paper, University of California at Berkeley, May 1992.

Schipper K. Thompson R. , “Evidence on the Capitalized Value of Merger Activity for Acquiring Firms,” Journal of Financial Economics (April 1983), pp. 85–120.

Schipper and Thompson support this conclusion by arguing that if prior operating success induced the 13% abnormal stock return, it is more likely that these firms would have expanded the existing (successful) lines of business or ventured into related lines, rather than into unrelated (conglomerate) activities, as most of the sample firms did. These days, of course, it is highly unlikely that an announcement of a conglomerate acquisition strategy would trigger a positive investor response.

Chaney P. Devinney T. Winer R. , “The Impact of New Product Introductions on the Market Value of Firms,” Journal of Business (October 1991), pp. 573–610.

Lev B. Penman S. , “Voluntary Forecast Disclosure, Nondisclosure, and Stock Prices,” Journal of Accounting Research (Spring 1990), pp. 49–76.

This gain reflects the tendency of forecasting firms to be above-average performers and thus to release “good news” forecasts. Note, however, that the positive market reaction at the time of the forecast caused firm values to increase well before the financial statements confirming the good performance were publicly released.

Skinner , op. cit.

Woolridge R. Ghosh C. , “Dividend Cuts: Do They Always Signal Bad News?” Midland Corporate Finance Journal (Summer 1985), pp. 20–32. An example of a “reasoned” cut: On December 6, 1983, Gould Corp. decreased its quarterly dividend from 43 to 17 cents per share, stating that the decision was intended to “conserve cash that can be used to finance the growth of its electronic business.” On the day of this 60% dividend cut announcement, Gould stock closed up $0.50, while the market was virtually unchanged.

Hoskin R. Hughes J. Ricks W. , “Evidence on the Incremental Information Content of Additional Firm Disclosures Made Concurrently with Earnings,” Journal of Accounting Research, supplement 1986, pp. 1–36.

Lev Thiagarajan , op. cit.

Foster G. , “Briloff and the Capital Market,” Journal of Accounting Research (Spring 1979), pp. 262–74. For a recent Briloff commentary, see the article on Waste Management Corp.: “Recycled Accounting,” Barron's, August 6, 1990. Waste Management's stock price plummeted 79% on that day (the Dow Jones industrials decreased 3.3%) for a total shareholder value loss of $1.5 billion.

For example, Perkin-Elmer Corp., in announcing its plan to offer the public up to 19% of its minicomputer business, stated in a Wall Street Journal advertisement (February 19, 1986): “Higher visibility and a sharp, singular focus will … lead to increased recognition in the financial community where shareholders will be able to benefit from its [the new subsidiary] full potential.”

Schipper K. Smith A. , “Equity Carve-Outs,” Midland Corporate Financial Journal (Spring 1986), pp. 23–32. In some cases the price increases were very large: For example, Condec Corporation's 1981 offer to sell 20% of the equity in its wholly owned subsidiary Animation resulted in a market-adjusted price increase for Condec of 19%.

Smiley R. , “Empirical Evidence on Strategic Entry Deterrence,” International Journal of Industrial Organization (June 1988), pp. 167–80.

For elaboration on the relation between disclosure and cost of capital, see Diamond D. Verrecchia R. , “Disclosure, Liquidity, and the Cost of Capital,” Journal of Finance (September 1991), 1325–59.

See Myers S. Majluf N. , “Corporate Financing and Investment Decisions When Firms Have Information that Investors Do Not Have,” Journal of Financial Economics (June 1984), pp. 187–221; where the link between the information gap (asymmetry) and decreased company investment is established.

For elaboration, Jensen M. Meckling W. , “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Journal of Financial Economics (October 1976), pp. 305–60.

See Stein J. , “Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior,” Quarterly Journal of Economics (November 1989), pp. 655–69. A specific example: Concerns with suppliers' loyalties are evident in the following comment. “Chrysler, like the others in the Big Three, does not want investors, suppliers or lenders to get the idea that it is paring spending for new models, a perception that would only worsen its problems on the showroom floor.” The New York Times, May 16, 1991, p. C1.

This is the concept of “neglected firms” in the finance literature. See Arbel A. Strebel P. , “Pay Attention to Neglected Firms,” Journal of Portfolio Management (Winter 1983), pp. 37–42. Also, Dubofsky D. Grott J. , “Relative Information Accessibility for OTC Stocks and Security Returns,” The Financial Review (February 1986), pp. 85–102.

For example, the Wall Street Journal, reviewing the monthly (7/15/1991 to 8/15/1991) changes in the “short interest” of Nasdaq stocks, noted [August 27, 1991] that the short interest was up in both Xoma Corp. (60%) and Centocor Inc. (46%), as the two biotechnology companies were locked in a patent battle. The average short interest in all OTC stocks increased only 5.6% over that 30-day period.

For example, Amihud Mendelson [“Liquidity and Cost of Capital: Implications for Corporate Management,” Journal of Applied Corporate Finance (Fall 1989), pp. 65–73] report that in their sample the spreads ranged between 0.5% of the stock price for the low-spread stocks to an average of 3.2% of the stock price for the group of large-spread stocks. When a stock is traded several times a year, a 3.2% cost for each trade will quickly add up to a very substantial expense.

For elaboration on the relation between information asymmetry and liquidity, see Glosten L. Milgrom P. , “Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders,” Journal of Financial Economics (March 1985), pp. 71–100, and Amihud Mendelson , op. cit.

“The key, I think, to having good communication with the investment community is to have large shareholders … their presence would close this communication gap [between management and shareholders] that otherwise reduces the value of large public companies with a broadly dispersed shareholder base… . In recent research, John Pound and I have found that across a broad sampling of industries, the presence of a large shareholder boosts price/earnings multiples by roughly 10 percent.” Zeckhauser R. , in “Lead Steer Round Table,” Journal of Applied Corporate Finance (Fall 1989), pp. 43–44.

For example, Pelzman S. , Regulation of Pharmaceutical Innovation: The 1962 Amendments (Washington, D.C.: American Enterprise Institute for Public Policy Research, 1974).

Porter M. , Competitive Strategy (New York, NY: The Free Press, 1980), p. 75.

For example, a survey revealed that the average cost of producing an annual financial report is $3.37 per copy [survey conducted in 1990 by Padilla, Speer, Beardsley, Inc.].

For discussion of the legal issues in disclosure, see, for example, Bloomenthal H. , Securities Law Handbook (New York, NY: Clark Boarman Company, Ltd., 1990); Hazen T. , The Law of Securities Regulation, 2nd edition (St. Paul, MN: West Publishers, 1989), Section 13.10; and Walton W. Brissman C. , Corporate Communications Handbook (New York, NY: Clark Boardman Company, Ltd., 1991), Chapter 2.

For the theory underlying this principle see Akerlof G. , “The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism,” Quarterly Journal of Economics (August 1970), pp. 488–500. Also, Milgrom P. , “Good News and Bad News: Representation Theorems and Applications,” Bell Journal of Economics (Autumn 1981), pp. 380–91.

For empirical evidence indicating that firms tend to disclose good news early and postpone the release of bad news, see Givoly D. Palmon D. , “Timeliness of Annual Earnings Announcements: Some Empirical Evidence,” The Accounting Review (July 1982), pp. 486–508. Also, Chambers A. Penman S. , “Timeliness of Reporting and the Stock Price Reaction to Earnings Announcements,” Journal of Accounting Research (Spring 1984), pp. 21–47.

See Loss L. Seligman J. , Securities Regulation, 3rd edition (Boston, MA: Little, Brown, 1991), p. 3517.

See Alexander J. , “Do the Merits Matter? A Study of Settlements in Securities Class Actions,” Stanford Law Review (February 1991), pp. 497–598.

In fact some legal scholars argue that it is easier for plaintiffs to prove management's intent to defraud (i.e., “scienter”) in the case of a failure to disclose information than in the case of an actual disclosure, see Bauman J. , “Rule 10b-5 and the Corporations Affirmative Duty to Disclose,” The Georgetown Law Journal (April 1979), p. 943.

This definition of information content of disclosures is consistent with that of Information (Communication) Theory [e.g., Shannon C. Weaver W. , The Mathematical Theory of Communication (Urbana, IL: The University of Illinois Press, 1964)], in which the information content of a message is measured by the extent of change it causes in the receiver's prior expectations with respect to an event. A change in expectations will generally lead to an action (e.g., buying the shares of the communicating company), hence the link between information content of disclosures and impact on the receivers' decisions and the consequent outcomes (e.g., a share price increase).

The effect of using alternative accounting techniques and estimates on stakeholders' (investors, suppliers, customers, regulators, employees, etc.) decisions is still to a large extent an open issue. Particularly intriguing is the question whether sophisticated investors can be “fooled” by accounting techniques, or whether they are able to “see through the numbers.” Accounting techniques may also affect managers compensation and loan covenants. For a discussion of these issues, see Watts R. Zimmerman J. , Positive Accounting Theory (Englewood Cliffs, NJ: Prentice-Hall, Inc., 1986).

On the “big bath” see Elliott J. Shaw W. , “Write-Offs as Accounting Procedures to Manage Perceptions,” Journal of Accounting Research (supplement 1988), pp. 91–119.

Evidence consistent with this use of accounting techniques is reported in DeAngelo L. , “Managerial Competition, Information Costs, and Corporate Governance,” Journal of Accounting and Economics (January 1988), pp. 3–36.

Lilien S. Hellman M. Pastena V. , “Accounting Changes: Successful Versus Unsuccessful Firms,” The Accounting Review (October 1988), pp. 642–56.

Dharan Lev [“The Valuation Consequences of Accounting Changes: A Multi-Year Examination,” working paper, Rice University, May 1991] provide evidence that companies engaged in aggressive (income increasing) accounting changes suffer, on average, significant market value declines during the five years after the change.

For evidence, Lev Thiagarajan , op. cit.; Imhoff E. Thomas J. , “Accounting Quality,” working paper, University of Michigan, 1989.

These company attributes were pointed out by the Treadway Commission [Report of the National Commission on Fraudulent Financial Reporting, October 1987] as characterizing companies which are frequently involved in fraudulent financial reporting.

For evidence, see Hoskin R. Hughes J. Ricks W. , op. cit.

Indeed Dharan [“Accounting Changes and Information about Earnings: An Examination with Dividend Signals,” working paper, Rice University, 1989] provides evidence that the price reaction to earnings increases accompanied by dividend increases is, on average, larger than the reaction to similar-size earnings increases announced without the dividend increase.

Conversely, decreases in insiders' holding adversely affects investors' perceptions. For example, in a report on The Limited, The Wall Street Journal [August 12, 1991, p. C2] notes: “Another possible concern [to security analysts] is that 19 company insiders have sold Limited stock this year. None have disclosed open-market purchases … The median insider sold 16% of holding.”

Evidence on investors' positive response to an increase in the performance-based component of managers' compensation is provided by Brickley J. Bhagat S. Lease R. , “The Impact of Long-Range Managerial Compensation Plans on Shareholder Wealth,” Journal of Accounting and Economics (April 1985), pp. 115–29.