|
COPYRIGHT 2003 American Accounting Association
I. INTRODUCTION
On October 23, 2000, the voluntary disclosure practices of corporations with publicly traded securities became subject to the requirements of the Securities and Exchange Commission's (SEC's) Regulation Fair Disclosure (FD). Regulation FD prohibits corporations from privately disclosing material information to select investors or securities markets professionals without simultaneously disclosing the same information to the public. Regulators intended FD to eliminate superior trading opportunities for recipients of firms' selective disclosures. (1) However, many securities markets professionals contend FD reduced the quantity and quality of information available to the capital markets, resulting in less accurate expectations of firm performance and larger price shocks when firms announce earnings (e.g., Securities Industry Association 2001; Association for Investment Management and Research 2001). In this paper, we empirically investigate whether the implementation of FD is associated, on average, with changes in the earnings-related information environment. (2) Specifically, we test for changes in (1) the informational efficiency of stock prices prior to firms' quarterly earnings announcements; (2) the accuracy and dispersion of analysts' earnings forecasts; and (3) the frequency of firms' voluntary disclosures. In general, we find no evidence the information available to investors prior to earnings announcements deteriorated after FD. On the contrary, we find some improvement in stock price efficiency and a substantial increase in the number of voluntary disclosures after FD's implementation.
The SEC implemented Regulation FD to address the commission's (particularly former chairman Arthur Levitt's) concern that firms communicate value-relevant information to select professional analysts and investors before disclosing it to the public. (3) Selective disclosure provides select investors an informational advantage from which they can profit at the expense of others, and the SEC was concerned this practice undermines investor confidence in the integrity of the capital markets. Regulation FD now requires that, when a firm's management intentionally discloses material information to select market participants, such as securities markets professionals or investors who may trade on the information, the firm must simultaneously make public that information. When a firm's management unintentionally discloses material information to select market participants, it must make that information public as soon as practical, but no later than 24 hours after the initial disclosure.
In contrast, analysts believe direct communication between management and analysts is a primary means by which corporations communicate performance-relevant information to the capital markets. The analysts' community suggests FD has impaired information available to investors, in part because FD prohibits firms from privately guiding analysts' earnings forecasts, which form the basis for investors' earnings expectations. For example, the director of research at Thomson Financial/First Call states, "You can't give guidance to individual analysts anymore; that will inevitably lead to wider ranges in estimates and more surprises" (Williams and McGough 2000). Additionally, FD may reduce the amount of detailed, performance-relevant information firms provide analysts, which also may impair their ability to forecast earnings and make buy-sell recommendations. (4) Furthermore, FD critics argue SEC 8-K filings and public announcements are insufficient substitutes for earnings guidance. When firms channel information through professional analysts, the analysts can guide the press, and ultimately investors, as to the information's appropriate context and meaning. However, since firms must now release information directly to the media, reporters and editors must draw inferences about context and meaning without the benefit of analysts' experience and expertise (Weber 2000). Additionally, FD critics suggest firms are less forthcoming in public announcements than in private conversations with analysts, partly because they fear litigation arising from improperly interpreted public announcements. Managers may also fear public disclosure of detailed information will benefit competitors, whereas professional analysts potentially use that information to improve earnings forecasts without disclosing competitively sensitive details (Opdyke and Lucchetti 2000; Weber 2000). Security Industry Association (SIA) spokesman Stuart Kaswell summarizes these concerns: "The playing field will be more level, but it will be empty" (Hassett 2000).
However, several factors may prevent deterioration in the information environment after the implementation of FD. First, analysts may be able to substitute information gathered from private search for information previously obtained directly from firms. For example, the majority of respondents to an Association for Investment Management and Research (AIMR) survey believe the accuracy of their earnings forecasts and the appropriateness of their stock recommendations will not suffer as a consequence of FD, despite reporting deterioration in private corporate communication to analysts (AIMR 2001). Second, companies may increase the quality and quantity of information dissemination through public disclosures. Finally, if private communication between firms and analysts cannot be (or is not) adequately monitored, FD may not successfully curtail selective disclosure to analysts. Therefore, the effect of FD on the financial information environment is an empirical question.
We analyze changes in various aspects of the financial information environment after the implementation of FD for a large sample of firms. Our test period consists of three post-FD quarters (the fourth quarter of 2000 and the first and second quarters of 2001). We compare each post-FD quarter to the latest like pre-FD quarter (the fourth quarter of 1999 and the first and second quarters of 2000, respectively). We first examine the effect of FD on the speed and extent to which stock prices anticipate information in upcoming earnings announcements. Specifically, we measure the "information gap" at various days prior to earnings announcements as the absolute deviation between the price on that day and the post-earnings-announcement stock price, after controlling for market-wide movements. A smaller information gap suggests the market has more information about the upcoming earnings announcement. The preponderance of our results suggests a smaller information gap over almost the entire quarter prior to earnings announcements, after FD. We next investigate the effect of FD on various aspects of analysts' forecasting performance. Although our univariate tests suggest that, on average, forecast accuracy declined and forecast dispersion increased after FD, regression analyses controlling for non-FD-related factors suggest FD had little effect on either forecast accuracy or forecast dispersion. Finally, we examine the effect of FD on the frequency of firms' voluntary public disclosures. We find a significant increase in voluntary earnings-related disclosures after FD. The increase in the number of firm-quarters with at least one disclosure is particularly significant.
In summary, we find no evidence that Regulation FD impaired the quality and quantity of investors' information prior to earnings announcements. We do not find deterioration in analysts' forecasting performance, but do find an improvement in the informational efficiency of prices prior to earnings announcements. We also find a marked increase in firms' voluntary disclosure frequency, which is consistent with firms substituting public disclosure for private communication through analysts.
Our results are potentially of interest to the SEC, which must assess the consequences of Regulation FD in a timely manner, especially given the criticism from the professional investment community. Our results are also potentially informative to the regulation's critics, largely securities markets professionals, since our systematic evidence suggests that their concerns that the regulation would have dire consequences for the financial information environment are likely unfounded. Finally, our results are potentially of interest to firms making disclosure decisions in the wake of this new regulation.
Our study provides early evidence on the cross-sectional average effects of FD on a broad range of issues related to the financial information environment. Recently, other researchers have explored the effect of FD on analysts' forecast performance in more detail. While broadly consistent with our results, this later work provides some interesting additional evidence. For example, Shane et al. (2001) find that errors in forecasts issued early in a quarter increase after FD, although there is no change for those issued later in the quarter. (5) Mohanram and Sunder (2002) find no change in analysts' forecast accuracy or dispersion, but find an increase in the idiosyncratic component of analysts' information (but no change in the common information component).
We organize the rest of the paper as follows. Section II describes the sample. Section III discusses changes in the informational efficiency of stock prices. Section IV presents analyses of analysts' forecasts. Section V presents analyses of firms' voluntary disclosures, and Section VI concludes.
II. SAMPLE AND DATA
We assess the effect of FD by analyzing, before and after FD, various proxies for firms' financial information environment prior to quarterly earnings announcements. To align calendar and fiscal quarters, we confine our sample to December fiscal year-end firms. Not all our sample firms announced 2000 third quarter earnings before FD's effective date (October 23, 2000). Hence, we exclude the third quarter of 2000 from our analysis and define the fourth quarter of 2000 and the first and second quarters of 2001 as our post-FD quarters. We match each post-FD quarter with its most recent analogous quarter prior to October 23, 2000. Accordingly, our pre-FD quarters are the fourth quarter of 1999 and the first and second quarters of 2000. By limiting our analyses to like quarters, we control for potential differences across quarters in stock price reactions to earnings (Mendenhall and Nichols 1988), analysts' forecast accuracy and dispersion, and voluntary disclosure frequency. Comparing quarters close in calendar time minimizes the risk that changes in other economic variables contaminate our results.
Our sample includes all December fiscal year-end firms with the following data available during our three pre- and three post-FD quarters: (1) current and previous quarters' earnings announcement dates; (2) current quarter and previous year's like-quarter actual earnings per share (EPS); (3) consensus EPS forecasts, where at least one analyst has updated his/her forecast since the previous quarter's earnings announcement; and (4) stock returns. (6) We obtain stock return data from CRSP and earnings announcement dates and actual and forecasted EPS data from First Call. Data for control variables, which we discuss in more detail later, are obtained from First Call, CRSP, or Compustat.
For each test, if a firm enters the sample in a post-FD quarter, we require that it also enter in the corresponding pre-FD quarter. Our final sample includes 5,072 pairs of pre-and post-FD observations from 2,025 distinct firms, with 1,669, 1,715, and 1,688 firms in the fourth, first, and second quarters, respectively. Missing data on one or more control variables causes us to use fewer observations in certain tests. This selection process biases our sample toward larger firms with relatively greater amounts of information available prior to their earnings announcements (Grant 1980; Atiase 1985; Freeman 1987; Kross and Schroeder 1989). Thus, our inferences may not apply to smaller companies with smaller amounts of publicly available information. Finally, to reduce the possibility our inferences are influenced by extreme observations, we winsorize all continuous variables at the 99th percentiles of the distributions of their absolute values.
III. EVIDENCE FROM THE INFORMATIONAL EFFICIENCY OF STOCK PRICES
In an efficient market, stock prices quickly and correctly reflect all value-relevant information. Accordingly, we begin our investigation of the effect of FD on information flows to the stock markets by analyzing the speed with which pre-announcement stock prices assimilate earnings information.
Earnings announcements reveal significant information about firm performance and move stock prices (Beaver 1968). However, the stock market anticipates much of this information and most of the price movement associated with earnings news precedes the earnings announcement (Bail and Brown 1968; Beaver et al. 1980). Superior pre-announcement information implies the market better anticipates earnings news and moves the price closer to its full information, post-announcement level (Freeman 1987). (7) Therefore, the absolute deviation between the price on any day prior to an earnings announcement and the post-announcement price is a measure of the information gap regarding the upcoming earnings announcement, with smaller deviations implying superior pre-announcement information.
Accordingly, on each of the 64 trading days (the approximate number in a quarter) prior to the announcement we compute the absolute cumulative abnormal return as [ACAR.sub.i,q,x] = |[[PI].sup.+2.sub.t = -x] (1 + [AR.sub.i,q,t]) - 1| where x is the number of days the accumulation window extends backward from the earnings announcement date, and [AR.sub.i,q,t] is firm i's abnormal return on day t relative to the earnings announcement date of quarter q. (8) Abnormal returns are prediction errors from firm-specific estimations of the market model over the year ending the day before the start of the fiscal quarter. (9) We define the earnings announcement date as the day containing the announcement if the announcement is during trading hours, and the day after if it is after trading hours. (10)
[ACAR.sub.i,q,x] measures the absolute percentage change in price, after abstracting from market-wide movements, from x days before to two days after an earnings announcement. Thus, it measures the quarter's earnings news that is not reflected in stock price as of x days prior to the announcement (i.e., the information gap). Higher [ACAR.sub.i,q,x]'s (ACARs) indicate larger information gaps. If, as critics suggest, FD reduced the flow of earnings-related information to market participants, ceteris paribus, we should observe higher ACARs after than before FD. Conversely, if FD reduced the information gap, ACARs should be lower for our post- than our pre-FD quarters.
Univariate Results
Figure 1 plots ACARs from 64 trading days before to two days after earnings announcements for both the pre- and post-FD quarters. Both the mean and median post-FD ACARs, in Panels A and B, respectively, are smaller than their pre-FD counterparts in the days leading up to and including the announcement day. The distance between the pre- and post-FD ACARs widens as time extends backward from the announcement, peaking at about day -30 and remaining relatively constant back to day -64. These plots suggest the information gap between the pre-announcement and the full-information post-announcement price is actually smaller post- than pre-FD.
[FIGURE 1 OMITTED]
The plots in Panels A and B display the absolute information flow for the pre- and post-FD quarters (i.e., they do not condition on the total information flow for the quarter). However, the post-FD plots lie below the pre-FD plots even at the beginning of the quarter, suggesting the total information flow over the quarter is smaller in our post- than pre-FD quarters. To measure the proportion of each quarter's total information impounded in price by any given day, we scale each day's mean or median ACAR by the mean or median, respectively, [ACAR.sub.i,q, - 64], so that each plot starts the quarter at 1.0 and ends at 0.0. We present these standardized plots in Panels C and D of Figure 1. (11) In general, they are consistent with the plots in Panels A and B. For the entire 67-day period, both the mean and median standardized post-FD ACARs, in Panels C and D, lie below their pre-FD counterparts, suggesting smaller information gaps post-FD and general improvement in the information available to the market.
Table 1 presents statistical tests of differences between the pre- and post-FD pooled cross-sectional mean and median ACARs for accumulation windows of five different widths. The last day of each window is the second day after the earnings announcement (i.e., day +2) and the first day is alternatively day...
Read the full article for free courtesy of your local library.
|
Bookmark this article
Print this article
Link to this article
Email this article
Digg It!
Add to del.icio.us
RSS
