10-K Reports Research Articles

Intellectual Property Protection in M&A Negotiations

In this paper, I show that a major share of the value of target firm’s intellectual property can be protected from expropriation by the acquirer through negotiating a compensating bidder termination fee (BTF), which is paid to the target in case the acquirer abandons the deal. I apply a capitalization model for intangible capital stocks to proxy for the component of intellectual property in target firm’s market value. The results suggest that, on average, for every dollar of target firm’s R&D capital stock, roughly 16 cents of protective share is incorporated in the BTF. I strengthen my causal interpretation with an instrument variables approach that exploits exogenous industry-level variation in R&D worker quota. The relation between target firm’s innovation activity and BTF size is more pronounced, if the target is a pioneer in its technology sector, if the target operates in an industry that sells unique products, if the target is assigned to the high-tech or healthcare industry, and if the target mentions “trade secrets” in its 10-K report filed with the SEC prior to deal announcement. The effect is further increasing in the degree of technological proximity as well as product market rivalry between acquirer and target. Extending prior research at the intersection of innovation, law, and M&A, this paper concludes that BTFs serve as a contract mechanism that provide target firms compensation for revelation of sensitive information in M&A negotiations if acquirers terminate deals. The option to include BTFs in M&A contracts thereby increases acquirers’ incentives to close the deal and increases targets’ ex-ante incentives to reveal innovative secret information.

The Effect of Trade Secrets Law on Stock Price Synchronicity: Evidence from the Inevitable Disclosure Doctrine

ABSTRACT We exploit the staggered recognition of the Inevitable Disclosure Doctrine (IDD) by U.S. state courts to examine the effect of trade secret protection on the amount of firm-specific information incorporated in stock prices, as reflected in stock price synchronicity. We find that after certain state courts recognize the IDD, firms headquartered in those states exhibit a significant increase in stock price synchronicity relative to firms in other states. We also find a significant decrease in the disclosure of proprietary information in the firms' 10-K reports. These results suggest that IDD recognition increases the proprietary cost of disclosure and, in response, corporate managers withhold more information. In addition, we find that the increase in stock price synchronicity and the decrease in the disclosure of proprietary information lead to increases in the firm's market share, cost of equity, and market-to-book ratio, suggesting that managers sacrifice capital market benefits for product market gains. Data Availability: Data used in this study are available from public sources identified in the study.

Readability of narrative disclosures, and corporate liquidity and payout policies

In this paper, we examine the relation between the readability of narrative disclosures in 10-K reports, and corporate liquidity and payout policies. We find that firms with less readable disclosures hold significantly more cash. We also find that this relationship is stronger for firms with weak corporate governance, and with higher financing constraints and refinancing risks. Further analysis also shows that firms with less readable disclosures pay fewer cash dividends and repurchase less stock. Our findings are robust to different estimation methods, and to alternative specifications of key variables. The findings from this study contribute to the emerging research that stresses the importance of 10-K report readability in protecting shareholder wealth.

Readability of Narrative Disclosures, and Corporate Liquidity and Payout Policies

In this paper, we examine the relation between the readability of narrative disclosures in 10-K reports, and corporate liquidity and payout policies. We find that firms with less readable disclosures hold significantly more cash. We also find that this relation between readability and cash holdings is stronger for firms with weak corporate governance, and with major financing constraints and refinancing risks. Further analysis also shows that firms with less readable disclosures pay fewer cash dividends and repurchase less stock. Our findings are robust to different estimation methods, and to alternative specifications of key variables. The paper contributes to the emerging research that stresses the importance of 10-K report readability in protecting shareholder wealth.

Fundamental Analysis of XBRL Data: A Machine Learning Approach

We conduct a fundamental analysis of detailed financial information to predict earnings. Since 2012, all U.S. public companies must tag quantitative amounts in financial statements and footnotes of their 10-K reports using the eXtensible Business Reporting Language (XBRL). Leveraging machine learning methods, we combine the high-dimensional XBRL-tagged financial data into a summary measure for the direction of one-year-ahead earnings changes. The measure shows significant out-of-sample predictive power: the area under the curve ranging from 67.52 to 68.66 percent is significantly higher than that of a random guess, which is 50 percent. Hedge portfolios are formed based on this measure during 2015-2018. The annual size-adjusted returns to the hedge portfolios range from 5.02 to 9.74 percent. These returns survive after accounting for transaction costs and using the five-factor Fama and French (2015) model. Our measure and strategies outperform those of Ou and Penman (1989), who extract the summary measure from 65 accounting variables using logistic regressions. Additional analyses suggest that the outperformance stems from both nonlinear predictor interactions missed by regressions and the use of more detailed financial data.

Tournament Culture and Corporate Misconduct : Evidence using Machine Learning

This paper examines the type of corporate culture that leads to misconduct activities. Taking the management's tone in the 10-K report as the culture, we found that a higher internal compete culture (or tournament culture) increases the rate of misconduct activities such as restatements, earnings management, and financial fraud. A 1% change in tournament culture increases the chance of misconduct activities by 5% due to the firm's idiosyncratic risk. We externally validate culture measures using the company's Glassdoor rating, CSR score, and other cultural proxies. The results are robust regarding systematic risk, market competition, governance characteristics, CEO effects, and endogeneity effects.

Information content of corporate reports of US medical companies

The document shows that corporate reporting is not only a source of information about the current state, results and trends of the company’s development, but also a thing that transfers its image to the external and internal environment. It is determined that the transfer of a charitable image to external recipients of such information about the companies’ activity operating in the social services is especially important. Based on the analysis of 10-K form reports in the 10 largest medical companies in the United States there were revealed information blocks, focusing on which the consumer will pay attention to a particular company, and not a competitor’s company.

Characterizing Cybersecurity Threats to Organizations in Support of Risk Mitigation Decisions

This study characterizes the cybersecurity threats experienced by organizations. Today's organizations face difficult decisions regarding the mitigation of cybersecurity threats. Taking different types of cybersecurity threats—physical, human, communication and data, and operational—this study applied topic modeling techniques on textual data gathered from 10-K reports of 87 organizations. A cluster analysis on the resultant topic weights showed three different clusters of organizations which were used to characterize the cybersecurity threats. Specifically, organizations in the manufacturing sector prioritized physical threats, whereas those in the information technology and finance sectors accorded greater importance to human, communication and data, and operational threats. This study offers preliminary characterization of cybersecurity threats that can be beneficial for organizational decision-makers. Implications for research and practice are discussed.

The Managerial Perception of Uncertainty and Cost Behavior

Extensive theoretical research demonstrates the pivotal role uncertainty plays in shaping a firm’s cost behavior. Our study contributes to this literature by conducting a comprehensive multivariate analysis of the inherent tension between the effects of price and demand uncertainty on cost elasticity and cost asymmetry. Using the occurrence of words implying uncertainty in forward-looking statements in the Management Discussion and Analysis section of 10-K reports to measure the managerial perception of the overall, price, and demand uncertainty, we provide evidence of a positive and significant association between price uncertainty and cost elasticity and a negative and significant association between demand uncertainty and cost elasticity. The former finding is consistent with managers’ desire to shift to a more elastic cost function in the face of high price uncertainty; the latter supports the hypothesis that firms facing demand uncertainty will increase their capacity of fixed resources to avoid disproportionately large production congestion costs associated with high demand realizations. We reconcile findings in prior studies by demonstrating that the association between demand uncertainty and cost elasticity is negative for manufacturing firms but is positive for firms in the healthcare sector. We also document that managerial perception of the overall uncertainty exacerbates the degree of cost asymmetry. Our empirical evidence supports the theoretical argument that the managerial perception of uncertainty and its components influences their resource allocation decisions, and suggests that any analysis of the relation between uncertainty and a firm’s cost behavior needs to be conducted in the context of a specific type of uncertainty and industry affiliation.

Privately-Held Companies: Legislation, Regulation, and Limited Dissemination of Financial Information

Publicly-traded companies have reporting and disclosure requirements set by the U.S. Securities and Exchange Commission (SEC), which includes the public disclosure of financial statements and an annual 10-K report. In contrast, privately-held companies most often do not meet the SEC filing requirements, and therefore, are not required to disclose financial information. For investors and business researchers, this can provide clear challenges for researching privately-held companies. This paper first highlights a sample of the significant legislation and rules affecting disclosure requirements of public and private companies. Then, it offers other government sources for company and industry financial information. Finally, it suggests further resources to educate business owners, investors, and business researchers.

Doyoureadme? Temporal Trends in the Language Complexity of Financial Reporting

Regulators, practitioners, and researchers are expressing growing concern over the readability of financial disclosures. Several recent regulatory guidelines are aimed specifically at simplifying the language of financial reporting in order to ensure that the reports can be read and understood by the public at large. However, quantitative scientific evidence of the evolving linguistic complexity of finance is scarce. In this work we introduce various methods for measuring the linguistic complexity of financial texts. Some of these methods rely on advanced Natural Language Processing (NLP) techniques unavailable when earlier studies were conducted. We apply these methods to decades’ worth of texts from various domains. We have found that 10-K reports have grown substantially longer, more complex and less readable. In terms of education necessary to comprehend them, this increased complexity translates to additional 2.2 years of schooling over the course of 18 years. A similar pattern of using highly complex language is also evident in financial news. The latter finding suggests that financial reality is becoming increasingly difficult to describe and explain. In contrast, the language of other corpora, including general news and scientific publications, has become more readable over the same period of time.

Bricks or Clicks? The Efficiency of Alternative Retail Channels

We examine the 10k reports for 122 of the largest US “retail” firms, and analyze the impacts on their operating costs and factor usage of what venues they use to sell their goods: traditional stores that they operate, internet sales, and wholesaling to other stores. We find that the firm profit rates (EBITA) are largely unaffected by the share of sales done through these three venues. However, the use of labor and space (real estate) significantly decreases as the Internet venue share increases. On the other hand a residual category of “costs”, which we attribute to shipping, increases sufficiently with the internet venue share to offset the advantage from greater labor and space productivity. In the end, firms using the internet venue appear able to deliver goods to consumer doorsteps for roughly the same cost that firms using traditional stores deliver goods to their shelves. However, consumers must incur an additional 24% of their average purchase price collecting goods from shelves. With this more comprehensive accounting the internet venue is seen to be more efficient.

Behind the curtain

The contract drug manufacturing industry is something of a black box. Contracts between pharmaceutical firms and their active pharmaceutical ingredient (API) suppliers are almost always confidential. But a sliver of light comes through in the annual 10-K reports and other filings that publicly traded drug companies must submit to the US Securities and Exchange Commission. In these reports, some, though not all, small biotech firms disclose their manufacturing partners. By scouring the 10-Ks of biotechs that won new drug approvals in 2018, C&EN uncovered the following three contract manufacturing relationships involving new antibiotics. One thing these stories make clear: developing a new antibiotic is hard; making money from it is even harder. Paratek Pharmaceuticals Paratek Pharmaceuticals won US Food and Drug Administration approval for Nuzyra (omadacycline) in October 2018. The drug, a modernized tetracycline, treats community-acquired bacterial pneumonia and acute skin and skin-structure infections. To manufacture Nuzyra, which launched commercially

How does environmental performance map into environmental disclosure?

Purpose Focusing on a sample of firms from environmentally sensitive industries over several years, this study aims to reexamine the association between environmental disclosure and environmental performance. Design/methodology/approach The authors use a panel data analysis to examine how the interaction between environmental performance and economic and legitimacy factors influence firms’ environmental disclosures. Findings Results suggest that environmental performance moderates the effect of economic and legitimacy incentives on firms’ propensity to provide proprietary environmental disclosure, with both sets of incentives being influential. More specifically, there appears to be a reporting bias based on the firm’s environmental performance whereas the high-performers disclose more environmental information in the three following vehicles: annual report, 10-K and sustainability reports combined. Results also show that economic and legitimacy factors influence the disclosure decisions of the low and high environmental performers differently. Practical implications Understanding the determinants of environmental disclosure for high and low environmental performers helps regulators to close the reporting gap between these firms. Social implications There is little evidence to suggest that firms with low-environmental performance attempt to use their disclosures to legitimize their environmental operations. Originality/value The study examines environmental disclosures of 78 firms over a period of 14 years in annual, 10-K and sustainability reports. The panel data analysis controls for significant cross-sectional and period effects.

Revenue Recognition (Topic 606) at Salesforce.Com, Inc

This case uses an array of carefully selected and excerpted revenue recognition related information contained in Salesforce.com's January 31, 2019, 10-K. Maria, the fictional protagonist, is seeking to understand those disclosures as part of her preparation for an upcoming job interview with the company. As such, she is relying on those disclosures to provide insights as to the company's main product/service lines, the events that signal when and how much revenue the company has earned (i.e., the essence of its business model), along with the related official generally accepted accounting principles (GAAP) criteria pertinent to the valuing and timing of recorded revenues. Excerpt UVA-C-2428 Rev. Jun. 5, 2020 Revenue Recognition (Topic 606) at Salesforce.com, Inc. After her previous review of the revenue recognition information provided by General Dynamics and Ford Motor Company (Ford) in their recent 10-K reports, Maria had become intrigued by the Financial Accounting Standards Board's (FASB's) latest revenue recognition and disclosure requirements. Prior to the FASB's issuance of its comprehensive new revenue recognition guidance and its follow-on official addendums and interpretations (all currently published as Accounting Standard Codification [ASC] 606, and often referred to simply as Topic 606), companies had to consider a myriad of revenue recognition rules, from various sources, with potentially contradictory and/or ambiguous requirements. Moreover, Maria had learned that many, if not most, of the known financial reporting frauds or misstatements in the recent past had pertained to companies' misreporting revenues. In general, those guilty companies had “pushed the envelope” in finding rationales for recording more revenues sooner than they should have. Topic 606 was largely intended to clarify what companies could do in reporting revenues for fiscal years beginning in 2018. One knowledgeable pundit summed up the arrival of Topic 606 onto the contemporary financial reporting scene in a particularly poignant way, stating, “The new accounting rules are considered by many to be the biggest change to accounting standards in the last 100 years. Noncompliance is a huge risk. Revenue recognition errors are the biggest reason for earnings restatements. Earnings restatements can lead to firings, fines, and even jail time.” The convergence of two desires were motivating Maria to take another look at some examples of the now-in-force revenue recognition practices. First of all, she was interested in companies that operated in the software-as-a-service (SaaS) industry sector. Second, she had an interview with Salesforce.com, Inc., next week, and she wanted to be well prepared. In particular, she had heard it expressed that the revenue recognition practices and related disclosures of a company were an informative window into a company's business model. She wanted to be well-versed on that for her interview. Before heading to San Francisco for her corporate interview, she assembled some important revenue-related information from the company's most recent 10-K, filed with the US Securities and Exchange Commission (SEC) (see Exhibits 1–3). Maria's Tasks . . .

CEO incentive compensation and stock liquidity

We document that the CEO pay-for-performance incentive positively predicts firm’s stock liquidity. The evidence is consistent with the hypothesis that, to mitigate their undiversified price risk and reduce the transaction costs, CEOs with high pay-for-performance incentive compensations exert extra efforts in shaping firms’ information environment to improve stock liquidity. We further identify three internal and two external channels through which incentivized CEOs stimulate firms’ stock liquidity. Specifically, we find that firms with highly incentivized CEOs tend to provide earnings guidance, file more readable 10-K reports, and perform more stock splits. In addition, these firms attract larger analyst following and have lower earnings forecast dispersions.

Readability of Narrative Disclosures in 10-K Reports: Does Managerial Ability Matter?

This study examines the association between managerial ability and the readability of narrative disclosures in 10-K reports. Using a large US sample from 1994 to 2015, we find that managerial ability is significantly positively associated with the readability of narrative disclosures in 10-K reports. We also find that this association is more pronounced for firms with high levels of profitability. In addition, firms’ financial performance mediates the association between managerial ability and the readability of 10-K reports. Further analysis shows that the association was more pronounced before the implementation of the plain English disclosure rules. These results are robust to alternative specifications of managerial ability, 10-K report readability, and the endogeneity concern. Overall, findings from this study suggest that managerial ability matters for improving the readability of corporate disclosures.

The Information Content of 10-K’s Disaggregation Quality on Future Firm Performance

We propose that the disaggregation quality (DQ) of 10-K reports, which measures the detail of accounting information based on a count of non-missing Compustat line items, is valuable in predicting firms’ future performance. Empirical results show that firms with higher DQ have higher subsequent profitability and valuation. The DQ can also positively predict future stock returns in the cross section. The return predictability is stronger for young firms, firms with higher return volatility, and in periods with high investor sentiment. The findings are robust to the inclusion of variables shown to be correlated with firm operating and stock performance in the literature.

Alignment of business and social media strategies: insights from a text mining analysis

ABSTRACTOrganisations utilise social media technologies for various customer engagement and external-facing activities in recent years. This research examines the extent to which the business strategies and social media strategies of organisations are aligned. Using a sample of 33 organisations competing in the information technology industry, the business strategies were operationalised using data extracted from the annual 10-K reports while the social media strategies were identified from the Twitter feeds. Topic modelling with latent semantic analysis revealed six different orientations in the business and social media strategies of organisations, which were used to evaluate alignment. This study also identified clusters of organisations with varying levels of alignment. Implications for research and practice are discussed.

It pays to partner with a firm that writes annual reports well ✰

Abstract We use strategic alliances as a setting to examine whether the readability of a firm's partner's 10-K matters. We find that the increase in the cumulative abnormal return (CAR) around the announcement of an alliance is relatively lower when the firm's partner in a strategic alliance has a less readable 10-K report. Additional tests show that the impact of the readability of a partner's 10-K is much stronger when investors suspect insufficient due diligence before the alliance's formation, when the partner is from a different industry, and when the alliance occurs before the Sarbanes–Oxley Act. Overall, our results show that the readability of a partner's annual report matters—it pays to partner with a firm that writes these reports well.