Predisclosure Information Research Articles

Role of stock price informativeness in shaping non-GAAP earnings disclosures

ABSTRACT Using 107,411 firm-quarter observations from 2004 to 2017, we find that managers are less likely to report non-GAAP earnings with the increase of stock price informativeness, suggesting that information from stock prices discourages non-GAAP reporting from firm managers. We further show that stock price informativeness influences managerial incentive of non-GAAP reporting through two channels: (a) direct monitoring and (b) the improvement in the information environment. Accordingly, we find that the constraining effect is more pronounced when a firm’s monitoring mechanisms are weak and when the pre-disclosure information environments are poor. In addition, we find that the quality of non-GAAP earnings improves with the increase of stock price informativeness. Collectively, our results are consistent with the notion that information from the secondary stock price plays an important role in guiding managerial non-GAAP earnings disclosures.

Impact of economic policy uncertainty on disclosure and pricing of earnings news

In this paper we examine the effect of economic policy uncertainty on reactions of capital market participants and actions of corporate managers. In particular, we investigate two issues: (1) whether the economic policy uncertainty has a short-term and long-term impact on the interpretation of earnings news and (2) whether the managers strategically time the release of good/bad news to the uncertainty in economic policies. We use a sample of 2973 unique firms from 1990 to 2016 and find that economic policy uncertainty lowers investors’ confidence in earnings, resulting in lower earnings response coefficient. Further test shows that the adverse effect of economic policy uncertainty on earnings informativeness is long-lasting and cannot be explained by the publicly available pre-disclosure information. We also find that firms are more likely to disclose bad news and losses when the economic policy uncertainty is high. These findings are not explained by earnings management and persist even after controlling for commonly used proxies of earnings management. Finally, we show that economic policy uncertainty is distinct from firm-specific uncertainty and that they both have incremental effects on the earnings response coefficient.

Effect of pre-disclosure information leakage by block traders

PurposeThis paper aims to investigate pre-disclosure information leakage by block traders and market reactions to disclosures of off-hours block trading compared to off-market trading.Design/methodology/approachStock responses were analyzed based on timely disclosures regarding Korean firms’ decisions to dispose of their own shares to improve their financial structures.FindingsThe results showed that pre-disclosure abnormal returns were generated in off-hours block trading. In contrast, on disclosure days, the returns for off-hours block trading were significantly lower than those for off-market trading. It was consistent with prior studies, indicating that block traders were related to information leakage and caused moral hazard problems.Originality/valueThe comparison between off-hours block trading and off-market trading provides important insights regarding block traders’ behavior. This study’s findings on the leakage of information from block traders indicate the need for firms to exercise caution when using block traders.

When Are Investors Rational?

ABSTRACTTaking our cue from certain recent advances in experimental psychology, the authors propose a plausible theory of conflict between rationality and inherent behavioral biases of investors. In this theory no investor is fully rational or fully behavioral at all times. An investor faces a continuum between behavioral and rational positions. A movement toward rationality is a choice; it is costly to be fully rational which requires serious mental calculations. On the other hand, there could be some benefits to rationality in special circumstances that compensate for the costs. Using a unique and extensive investor-level database, the authors show that the degree of nonrationality decreases as rational behavior becomes more attractive. In the empirical setting, the proxy for rational behavior is investor's use of private predisclosure information during earnings announcement periods, while the disposition effect they display serves as an estimate of their behavioral bias. The paper contributes to the existing literature in several dimensions.

Market Segmentation, Information Asymmetry and Investor Responses in the Chinese A- and B-Markets

This paper examines changes in returns and trading volumes around earnings announcements for firms which have both A-shares (traditionally for local investors only) and B-shares (traditionally for foreign investors only) in China. It considers the impact of regulatory changes which reduced the segmentation of local and foreign investors across the two classes of shares. We find that both the A- and B-markets experience significant price changes around earning announcements. When the two markets are fully segmented, the magnitude of price changes in the A-share market are significantly smaller than the B-market which lends empirical support to the previous claim that the B-market is less informed. The changes in trading volume indicate that the B-market investors have less divergent expectations and interpretations of the pre-disclosure information compared to the A-market investors.However, when regulatory changes reduced the level of segmentation, the price and volume reactions in the two markets became more consistent. The results suggest that the A- and Bmarkets are more integrated as a result of the regulatory changes.

Market Reactions To Company Layoffs: Evidence On The Financial Distress Versus Potential Benefit Hypothesis And The Effect Of Predisclosure Information

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;">The current study extends theory developed by Malatesta and Thompson (1985) to the area of corporate downsizing, and finds that the magnitude of the stock price reaction to announcements of corporate layoffs is a function of two factors, (1) the economic impact of the announced layoff, and, (2) the degree to which the announcement and signal about the underlying conditions related to the announcement have been anticipated by investors and incorporated previously into the stock price (predisclosure information).</span></span></p><p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;"> </span></span></p><p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;">For firms experiencing a negative overall stock price reaction at the date of a layoff announcement, the larger the layoff (proxy for economic impact), the more <strong style="mso-bidi-font-weight: normal;"><span style="color: black;">negative</span></strong> the stock price reaction.<span style="mso-spacerun: yes;">  </span>Also for these firms, the smaller the firm size (proxy for the level of predisclosure information), the more <strong style="mso-bidi-font-weight: normal;"><span style="color: black;">negative</span></strong> the stock price reaction. This provides evidence that for some firms, the financial distress effect dominates, and the market incorporates previously unknown negative information into the stock price, which results in the negative stock price reaction.<span style="mso-spacerun: yes;">  </span>For these firms, the larger the impact and the less the event is anticipated, the more negative is the stock price reaction.</span></span></p><p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;"> </span></span></p><p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;">For firms experiencing a positive overall stock price reaction at the date of a layoff announcement, the larger the layoff (proxy for economic impact), the more <strong style="mso-bidi-font-weight: normal;"><span style="color: black;">positive</span></strong> the stock price reaction.<span style="mso-spacerun: yes;">  </span>Also for these firms, the smaller the firm size (proxy for level of predisclosure information), the more <strong style="mso-bidi-font-weight: normal;"><span style="color: black;">positive</span></strong> the stock price reaction. This provides evidence that for some firms, the potential benefit effect dominates.<span style="mso-spacerun: yes;">  </span>The market has previously incorporated negative information associated with the conditions leading up the layoff, and is now incorporating positive information about the benefits to be achieved by the layoff, which results in the positive stock price reaction.<span style="mso-spacerun: yes;">  </span>For these firms, the larger the impact and the less the event is anticipated, the more positive is the stock price reaction.</span></span></p><p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;"> </span></span></p><p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: "Times New Roman","serif"; text-shadow: none;"><span style="font-size: x-small;">In this study, hypotheses are developed which combine the effects of both economic impact and predisclosure information with the financial distress and potential benefit hypotheses developed in prior research in corporate downsizing.<span style="mso-spacerun: yes;">  </span>Instead of offering the these two hypotheses as competing and mutually exclusive, evidence is provided that supports the conclusion that these hypotheses simultaneously explain <span style="color: black; mso-bidi-font-style: italic;">concurrent</span> and <span style="color: black; mso-bidi-font-style: italic;">additive</span><span style="color: black;"> effects on the stock price reaction to announcements of company layoffs.<span style="mso-spacerun: yes;">  </span>Finally, results indicate that the relationship between economic impact, predisclosure information and stock price reaction to layoff announcements depends on the relative dominance of the signals provided by the layoff about both financial distress and potential benefit.</span></span></span></p>

Evaluation on financial risk and abnormal return: evidence from China’s listed companies

From 1998, China’s stock exchanges had classified listed companies as “Special Treatment” (ST) companies when these companies were involved in financial distress for the defined period. Principally, this study investigate that volatility the cumulative abnormal returns (CAR) before ST event, and interpret what factors will affect CAR. Using logistic regression constructs a financial distress prediction model to acquire distress probability. Furthermore, this paper explores pre-disclosure information (PDI) in advanced CAR regression model instead of traditional financial indexes. The main results indicate that the most obvious observation date of firms’ CAR is from pre 20 days relative to ST event, and both distress probability and proxy indicator for PDI are signifying in the model.

The Frequency of Financial Analysts' Forecast Revisions: Theory and Evidence about Determinants of Demand for Predisclosure Information

Abstract: A fundamental property of a financial market is its degree of price informativeness. A major determinant of price informativeness is predisclosure information collected by financial analysts and then privately disseminated to clients, who make the recommended trades. We develop a dynamic model of the analyst's optimal strategy of forecast revision frequency with endogenous analysts and endogenous traders. We then empirically test the model's predictions. We find that forecast revision frequency is positively associated with earnings variability, trading volume, and earnings response coefficients, and negatively associated with skewness of trading volume. Thus, we find strong empirical support for our dynamic model.

Institutional stakeholdings and better-informed traders at earnings announcements

Utama and Cready [Utama, S., Cready, W.M., 1997. Institutional ownership, differential predisclosure precision and trading volume at announcement dates. Journal of Accounting and Economics 24, 129–150] use total institutional ownership to proxy for the proportion of better-informed traders, an important determinant of trading around earnings announcements. We argue that institutions holding small stakes cannot justify the fixed cost of developing private predisclosure information. Also, institutions with large stakes generally do not trade around earnings announcements since they are dedicated investors or face regulations that make informed trading difficult. However, institutions holding medium stakes have incentives to develop private predisclosure information and trade on it; we show that their ownership is a finer proxy for the proportion of better-informed traders at earnings announcements.

Institutional Stakeholdings and Better-Informed Traders at Earnings Announcements

Utama and Cready (1997) use total institutional ownership to proxy for the proportion of better-informed traders, an important determinant of trading around earnings announcements. We argue that institutions holding small stakes cannot justify the fixed cost of developing private predisclosure information. Also, institutions with large stakes generally do not trade around earnings announcements since they are dedicated investors or face regulations that make informed trading difficult. However, institutions holding medium stakes have incentives to develop private predisclosure information and trade on it; we show that their ownership is a finer proxy for the proportion of better-informed traders at earnings announcements.

The information content of earnings announcements in Denmark

PurposeThe purpose of this paper is to examine the reaction to earnings announcements in a small stock market.Design/methodology/approachThe paper uses the traditional event study method to examine the information content of annual earnings announcements in the small Danish stock market from 1999‐2004.FindingsThe paper finds abnormal volatility in the days surrounding the announcements, indicating that they contain relevant information for the stock market. The abnormal volatility persists several days after the announcement, suggesting that the information environment of this small stock market works to decrease the speed of adjustment. In addition to this sign of inefficiency, the paper finds significant positive abnormal returns accompanying the announcements. These results are robust across various methodologies. Surprisingly, the paper finds a positive correlation between the information content and predisclosure information. This contradicts previous studies, and it is interpreted as evidence of a low level of pre‐announcement information. Confirming the results of similar studies, the paper finds that unexpected earnings are best proxied using a model based on consensus analyst forecasts.Originality/valueThis paper contributes to the existing literature by analyzing the information content of earnings announcements in a small stock market with accounting standards that are congruent with the International Accounting Standards.

Internal Control Weaknesses and Information Uncertainty

We analyze a sample of 330 firms making unaudited disclosures required by Section 302 and 383 firms making audited disclosures required by Section 404 of the Sarbanes-Oxley Act. We find that Section 302 disclosures are associated with negative announcement abnormal returns of -1.8 percent, and that firms experience an abnormal increase in equity cost of capital of 68 basis points. We conclude that Section 302 disclosures are informative and point to lower credibility of disclosing firms' financial reporting. In contrast, we find that Section 404 disclosures have no noticeable impact on stock prices or firms' cost of capital. Further, we find that auditor quality attenuates the negative response to Section 302 disclosures and that accelerated filers - larger firms required to file under Section 404 - have significantly less negative returns (-1.10 percent) than non-accelerated filers (-4.22 percent). The findings have implications for the debate about whether to implement a scaled securities regulation system for smaller public companies: material weakness disclosures are more informative for smaller firms that likely have higher pre-disclosure information uncertainty.

Internal Control Weaknesses and Information Uncertainty

We analyze a sample of 330 firms making unaudited disclosures required by Section 302 and 383 firms making audited disclosures required by Section 404 of the Sarbanes-Oxley Act. We find that Section 302 disclosures are associated with negative announcement abnormal returns of −1.8 percent, and that firms experience an abnormal increase in equity cost of capital of 68 basis points. We conclude that Section 302 disclosures are informative and point to lower credibility of disclosing firms' financial reporting. In contrast, we find that Section 404 disclosures have no noticeable impact on stock prices or firms' cost of capital. Further, we find that auditor quality attenuates the negative response to Section 302 disclosures and that accelerated filers—larger firms required to file under Section 404—have significantly less negative returns (−1.10 percent) than non-accelerated filers (−4.22 percent). The findings have implications for the debate about whether to implement a scaled securities regulation system for smaller public companies: material weakness disclosures are more informative for smaller firms that likely have higher pre-disclosure information uncertainty.

Predisclosure Information Search Incentives, Firm Size, Analysis Following and Corporate News

This paper explores whether firm size or analyst coverage is a more significant variable in explaining the richness associated with a firm’s information environment. The results presented in prior research investigating this issue are conflicting. The paper contributes to the literature by adopting a broader measure of a firm’s total information environment than that employed in prior research. The sample of stocks is drawn from the constituents of the FTSE 100 and FTSE 250 indices over the two-year period 1 January 1994 to 31 December 1995. Both variables (size and coverage) are found to be significantly related to firm information availability in a univariate sense. However, in a multivariate context firm size dominates analyst coverage and analyst coverage ceases to be statistically significant. The results have important implications for researchers who incorporate proxies for the richness associated with a firm’s information environment (“predisclosure information availability”) in measuring the price and/or trading volume response to corporate news events.

Differential Precision of Predisclosure Information across Traders and Trading Volume at Earnings Announcements

Kim and Verrecchia (1991a) propose that volume reaction to a public announcement is proportional to the product of absolute price change at the announcement and a measure of differential precision of predisclosure information across traders. We use ownership by institutions with medium stakes (between 1 to 5 percent of outstanding shares) as a measure of differential information precision, given that these institutional investors, as compared to other institutional and individual investors, are likely to have more precise predisclosure information and are more likely to trade at earnings announcements based on their belief revision about stock value. We examine this proposition in the context of earnings announcements and obtain results consistent with the theory. Tests of the theory by prior studies have yielded somewhat inconclusive results.

Public Predisclosure Information, Firm Size, Analyst Following, and Market Reactions to Earnings Announcements

Abstract: This study examines the effects of public predisclosure information on market reactions to earnings announcements. We develop an empirical measure of public predisclosure information impounded in price prior to earnings announcements by cumulating abnormal returns on public news release dates during the quarter. Consistent with prior literature, we document a negative association between this measure and market reactions to subsequent earnings announcements. Moreover, we find that after controlling for this measure, firm size and analyst following are significantly positively associated with market reactions to earnings announcements. Contrary to prior empirical evidence, our results suggest that, after controlling for actual predisclosure information impounded in price, market reactions to earnings announcements are greater in magnitude for larger, more widely‐followed firms than for smaller, less widely‐followed firms.

Predisclosure Trading Volume and Firm Size: A Test of the Economic Rationale for the Differential Information Hypothesis

Atiase [1980] hypothesized that private information production and dissemination prior to an earnings announcement is an increasing function of firm size. The economic rationale behind this hypothesis was that large firms have higher share liquidity, which conceals informed trade and increases the return to private information acquisition. While empirical researchers commonly use firm size as a control variable for the quality of predisclosure information, the economic rationale behind the differential information hypothesis has not been verified. Using all 10 CRSP firm size deciles, we document a positive relation between predisclosure share turnover and firm size. We find that predisclosure share turnover is positively related to institutional investment and analyst following, suggesting that sophisticated investors are attracted to highly liquid firms where they can conceal their informed trades. We also find evidence that predisclosure share turnover increases the amount of earnings-related information impounded in stock price in the predisclosure period, but this effect is driven by small firms. Investors in large firms appear to be successful at concealing their informed trades.

Public Predisclosure Information, Firm Size, Analyst Following, and Market Reactions to Earnings Announcements

This study examines the effects of public predisclosure information on market reactions to earnings announcements. We develop an empirical measure of public predisclosure information impounded in price prior to earnings announcements by cumulating abnormal returns on public news release dates during the quarter. Consistent with prior literature, we document a negative association between this measure and market reactions to subsequent earnings announcements. Moreover, we find that after controlling for this measure, firm size and analyst following are significantly positively associated with market reactions to earnings announcements. Contrary to prior empirical evidence, our results suggest that, after controlling for actual predisclosure information impounded in price, market reactions to earnings announcements are greater in magnitude for larger, more widely-followed firms than for smaller, less widely-followed firms.

Quality of Information and Volatility Around Earnings Announcements

On the basis of theoretical work of Kim and Verrecchia (1991a, 1997), this paper investigates the association between volatility around earnings and dividend announcements and the amount of pre-announcement information and the precision of the announced news for a sample of 212 firms drawn from the London Stock Exchange for the period January 1990 to December 1998. The aforementioned theory suggest that the variance of price change around announcement periods is decreasing in the amount of pre-announcement information but increasing in the precision of the disclosed news. The volatility of stock returns in the event window, natural logarithm of the average market value of a firm over the sample period, and the surrogate of precision derived from analytical work of KV (1991a) are assumed to be the operational measures for the variance of price change around announcement periods, the amount of pre-announcement information, and the precision of the announced news respectively. Tests are conducted using both GJR-GARCH (1,1) and the absolute return measure of volatility. After controlling for the magnitude of the average change of earnings per share, the net change in the degree of leverage, and the level of stock market volatility around firm specific news, the following conclusions emerge. First, it is documented that the volatility of stock returns around announcement periods is negatively related to the amount of pre-announcement information. Consistent with Grant (1980), this finding suggests that (small) firms with relatively less pre-announcement information experience high levels of uncertainty before announcement. This high pre-release uncertainty causes analysts and market participants to disagree about the implications of the forthcoming earnings and dividends announcements. When the announcement becomes imminent it tends to contain a lot of surprises that are translated into higher announcement period volatility. Second, it is found that the precision of the disclosed news plays a significant and important role in explaining shifts in volatility around event windows. In more specific terms, the volatility of stock returns around announcement periods is found to be directly proportional to the precision of the information released. Thus, the precision of an announcement is likely to influence investors' trading decisions around future earnings and dividends announcement dates. The primary conclusions of this paper are robust to the announcement of good or bad news, and remain qualitatively unchanged under a number of alternative assumptions about the way we estimate announcement period volatility. To the extent that the surrogates used for the quality of the predisclosure information and the precision of the news disclosed are appropriate operational measures of the unobservable theoretical constructs of precision implied by Kim and Verrecchia (1991a, 1997) analytical work, the evidence presented here is consistent with their theoretical predictions.

Factors Associated With Differences in the Magnitude of Abnormal Returns Around NYSE Versus Nasdaq Firms' Earnings Announcements

This study provides an explanation for the puzzle documented in prior accounting research. Grant (1980) finds that the magnitude of earnings announcement week abnormal returns is higher, on average, for firms traded over-the-counter than for NYSE firms. Atiase (1987) shows that this incremental persists even after controlling for firm size. We investigate potential explanations for this incremental exchange effect. We first show that even after controlling for differences in firm size, Nasdaq firms have less rich information environments and enjoy greater growth opportunities than NYSE firms. We then investigate whether differential predisclosure information environments and/or growth opportunities can explain the incremental exchange effect. The results indicate that although the absolute magnitude of the earnings announcement-related abnormal returns is inversely related to proxies for the amount of predisclosure information, the incremental exchange effect cannot be explained by differences in the predisclosure information environment. In contrast, after controlling for differences in growth opportunities across NYSE versus Nasdaq firms, and investors' heightened sensitivity to Nasdaq firms' growth opportunities in particular, there is no significant incremental exchange effect (whether or not we control for predisclosure information). These results suggest that the incremental exchange effect puzzle documented in prior research is more likely to reflect growth-related phenomena than differences in the predisclosure information environment.