Proprietary Costs Research Articles

Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Forecast Errors

Andre, Filip, and Modovan (2016) explores the characteristics—quality and quantity—of segment disclosures under IFRS 8 and their usefulness to financial analysts in accurately estimating earnings per share (EPS). The authors measure quantity of disclosures as the number of segment-level line items disclosed in financial statements and quality as the cross-segment variation in profitability. The results provide evidence that managers solve the issue of proprietary costs by decreasing either the quantity of disclosure below the level of standards' guidance or the quality of disclosures on operating segments, thus reducing the overall information included in disclosures. Results also show that it is difficult even for a sophisticated group of financial statement users such as financial analysts to fully understand the quality of segment disclosures and that too much disclosure quantity might create a “foggy” environment, where even sophisticated investors can have troubles using disclosed information to forecast earnings.

Independent Directors and CSR Disclosures: The moderating effects of proprietary costs

AbstractThe aim of this paper is two‐fold: (i) to evidence if the role of independent directors regarding the disclosure of corporate social responsibility (CSR) information is determined by the aim of protecting shareholders' value; and (ii) to highlight whether non‐executive directors only have incentives to disclose this information when it does not damage ownerships' interest, being a trade‐off between the benefits of reducing the information asymmetry in capital markets and the cost of aiding competitors by revealing proprietary information. From an international sample from 2004 to 2010, we proposed several Tobit regressions for panel data. This research evidences that independent directors show an initial opposition to CSR disclosure practices except in firms with a higher yearly cost of equity capital and lower proprietary costs. Moreover, this opposition is avoiding if there is an assurance statement that reduces their reputation risks associated with potential misleading CSR information. Copyright © 2016 John Wiley & Sons, Ltd and ERP Environment

The benefits of specific risk-factor disclosures

Practitioners have long criticized risk-factor disclosures in the 10-K as generic and boilerplate. In response, regulators emphasize the importance of being specific. By using a computing algorithm, this paper establishes a new measure (Specificity) to quantify the level of specificity of firms’ qualitative risk-factor disclosures. We first examine determinants of variations in Specificity, and document that firms with high proprietary costs provide less specific risk-factor disclosures. More importantly, we find that, controlling for numerous determinants, the market reaction to the 10-K filing is positively and significantly associated with Specificity. In addition, our results suggest that analysts are better able to assess fundamental risk when firms’ risk-factor disclosures are more specific. Together, these findings suggest that more specific risk-factor disclosures benefit users of financial statements.

Technological Peer Pressure and Product Disclosure

Competition is multifaceted, and corporate disclosure can be of various types. The alignment between the aspect of competition and the type of disclosure determines the proprietary costs of disclosure. Such an alignment has been overlooked in many prior empirical studies when examining managerial disclosure decisions. In this study we examine the association of technological peer pressure — the technological aspect of competition — with voluntary disclosure of product-development-related information. Given a strong alignment between the technological aspect of competition and product disclosure, we predict and find a negative association between technological peer pressure and product disclosure. In contrast, we find no association between technological peer pressure and management earnings forecasts — the most popularly used type of voluntary disclosure — because of a weak alignment between the technological aspect of competition and earnings projections. Our study advances the understanding of managerial disclosure decisions by highlighting the importance of aligning the type of disclosure with a given aspect of competition.

Organized Labor and Debt Contracting: Firm-Level Evidence from Collective Bargaining

ABSTRACT This paper employs a firm-level collective bargaining dataset to investigate the effect of labor, as an important stakeholder of a firm, on debt contracting. I conjecture and provide evidence that firms with strong organized labor prefer bank loans to public bonds because, by communicating with banks privately, unionized firms can reduce the adverse selection costs while preserving the information asymmetry with organized labor. Furthermore, I show that organized labor influences the structure of syndicated loans. When firms with strong unions withhold public disclosures, but communicate privately with lead lenders, heightened information asymmetry between the lead lenders and the participant lenders induces the lead lenders to retain larger shares of the loans and form more concentrated syndicates. Overall, this study demonstrates that the proprietary costs of disclosure related to organized labor significantly influence firms' debt contracting decisions and outcomes. Data Availability: Data are available from sources identified in the text.

Product Market Competition and Managerial Disclosure of Earnings Forecasts: Evidence from Import Tariff Rate Reductions

ABSTRACT This study examines the effect of product market competition on managerial disclosure of earnings forecasts using large reductions in U.S. import tariff rates to identify an exogenous increase in competition for domestic firms in U.S. product markets. Our difference-in-differences estimations show that tariff reductions are associated with a significant decrease in management forecasts of annual earnings by U.S. domestic firms. Further, this decrease is more pronounced when the tariff rate reduction triggers a greater increase in imports and when the forecasts are likely to incur higher proprietary costs. Our findings are consistent with competition from existing rivals reducing voluntary disclosure through increased proprietary costs.

Determinants of Voluntary Disclosure of Sales in Small Private Companies in Belgium

AbstractSmall businesses are the backbone of the economy in many countries. In Europe, for example, small companies represent more than 90 per cent of all companies (e.g., Lukacs, ). Although these companies represent such an important portion of the economy, few studies have examined their voluntary disclosure decisions. Because small companies have certain unique characteristics compared with their larger counterparts, the general applicability of past voluntary disclosure studies to small companies is questionable. Drawing on agency and proprietary cost theory, this study investigates whether ownership, competition, and accountant factors influence the decision to disclose financially sensitive information on a voluntary basis. Our results (using an e‐mail questionnaire to small private companies in Belgium, n = 1,068) indicate that nearly 40 per cent of the responding companies are not aware of their disclosure behavior. For companies that are aware of their disclosure behavior, the logistic regression analysis demonstrates that factors relating to the separation of ownership and control, namely the type of ownership and number of shareholders, are among the most important determinants in the voluntary disclosure decision of small private companies. Companies with at least one legal entity as an owner of a company are less likely to disclose, while companies with more shareholders are more likely to disclose. We also provide evidence that perceived competition and the default setting of the accounting software used have a significant influence on the voluntary disclosure behavior.

Bank Relationships and Private Firms’ Financial Reporting Quality

Private firms with relatively high (proprietary) costs of disclosure may benefit from a close relationship with a bank. Relationship lending is based on intertemporal contracting that assumes that the bank is able to acquire private information about the firm and, moreover, to keep this information private. For both reasons, we expect and find that private firms with fewer bank relationships exhibit lower levels of financial reporting quality. Controlling for many other factors, firms with a single bank relationship disclose their financial reports about 14 days later. The size of such firms’ financial reports is also smaller, containing approximately 8% fewer words than the median report. Firms with a single bank relationship also exhibit more earnings management, exceeding the median value of the three-year sum of absolute discretionary accruals by about 20%. The results are robust to different econometric specifications, including endogeneity concerns. They indicate that private firms choose to be opaque in the presence of fewer lending relationships.

Multidimensional Competition and Corporate Disclosure

AbstractIn this paper, we argue that the influence product market competition exerts on disclosure is defined by the combined effect of the incentives and disincentives to disclose raised by the multiple competition dimensions. We distinguish between firm‐ and industry‐level competition measures, and we hypothesize that the former raises agency and proprietary costs, whereas the latter creates incentives to disclose either to fulfil the owners’ need for information to monitor managers or to deter the entrance of new competitors in the industry. Our research design allows for non‐monotonic relationships between competition and disclosure as well as for interactions between competition dimensions. Using a sample of US manufacturing companies, we gather evidence that is consistent with our hypotheses. First, we find an inverted U‐shape relationship between corporate disclosure and a firm's abnormal profitability, which is suggestive of firms being reluctant to disclose when they are underperforming (outperforming) their rivals because of the fear of unveiling agency conflicts (raising proprietary costs). Second, we observe a U‐shape relationship between corporate disclosure and industry profitability, although this U design evolves to approximate a rising function as the protection provided by entry barriers increases.

Technology Spillover and Corporate Disclosure Transparency

In recent decades the United States has become increasingly a knowledge-based economy as evidenced by a surge in patents. Companies strive to develop valuable technologies and to protect them from appropriation by competitors. We examine the implications of technological competition for patent-issuing firms’ redactions of technological information from new material contracts included with 10-K filings. We find that firms facing more intense technological competition are more likely to redact such information, and they redact it to a greater extent, presumably due to proprietary cost concerns. Total redactions (both technological and non-technological) also are greater for these firms. The results persist after controlling for a variety of product market competition measures. The results are more pronounced for firms with greater growth options, firms less financially constrained, and firms having recently sued others for patent infringements. The results are robust to using exogenous changes in state level R&D tax credits as an instrumental variable to address the endogeneity concern of technological competition. Our inferences can be extended to technologically innovative firms that do not hold patents. In summary, we document the implications of technological competition for redaction of proprietary technological information and these implications are distinct from and incremental to those of product market competition.

Do the FASB's Standards add Shareholder Value?

We examine the cost effectiveness, from the shareholders’ perspective, of the accounting standards issued by the FASB during 1973-2009. In particular, we evaluate (i) the stock market reactions of firms affected by the standards surrounding the events that changed the probability of issuance of these standards; and (ii) whether the market reactions are related, in the cross-section, to affected firms’ agency problems, information asymmetry, proprietary costs, contracting costs, and estimation risk changes. The average standard is a non-event from the investors’ perspective. We find that 104 of the 138 standards we examine are associated with no change in shareholder value. Thirty-four standards are associated with significant abnormal returns. Of these 19 (15) are shareholder value decreasing (increasing). Thus, a mere 11% of the standards improve shareholder value. The fair value pronouncements (SFAS 105, 107, 115) and the R&D expensing standard (SFAS 2) cause the highest negative stock price reaction whereas standards related to the securitization of mortgage backed securities (SFAS 134) and the disclosure of derivative instruments (SFAS 119) are associated with the highest positive returns. Surprisingly, 25 standards are associated with an increase in estimation risk. Stock returns associated with standards are higher for affected firms that experience a decrease in estimation risk. Principles-based standards are associated with more positive stock price reactions relative to rules-based standards. However, standards that involve more managerial estimates are associated with negative stock price reactions.

Technological and innovation disclosure: determinants for Tunisian companies

This study aims to identify determinants of voluntary disclosure about innovation and technology (I&T) by using a theoretical framework of the signal theory and the proprietary costs theory. The analyses are concerned with the Tunisian context where the conceptual framework motivates firms to communicate about their innovation efforts and their technological choices which are generally viewed as competitively sensitive and proprietary in nature. This paper incorporates a new I&T disclosure index to examine factors enhancing and against I&T disclosure. It applies a multiple regression analysis using panel data and content analysis of the annual reports of 18 Tunisian listed firms over the period 1997 to 2007. The findings indicate that companies with more significant growth potential and more uncertainty of their future earnings disclose less information on their innovation efforts and technological choices. Results indicate also that the level of I&T disclosures is reduced when entry barriers are relatively high.

Determinants of segment disclosure deficiencies and the effect of the SEC comment letter process

Segment reporting is one of the most common areas discussed in the SEC comment letters. Using a sample of hand-collected SEC comment letters, and companies’ response letters related to recent segment disclosure, this paper investigates determinants of segment disclosure deficiencies and the subsequent consequences after companies revised these deficiencies. The results show that segment disclosure deficiencies are positively associated with proxies for proprietary costs. Further analyses find that disclosure deficiencies related to aggregation of segments are more likely to be intentional, while other deficiencies are more likely due to business complexity. This paper also provides evidence on the effectiveness of the SEC comment letter process. Companies that revised the number of segments after receipt of SEC comment letters experienced decreased analysts’ forecast errors, reduced forecast optimistic bias and smaller forecast dispersions.

The Effect of Supplier Relationships on Disclosures of Forward-Looking Information

This study investigates whether the need for supplier relationship-specific investments influences the disclosure of forward-looking information. Prior literature on relationship-specific investments argues that suppliers are reluctant to invest in relationship-specific assets, since the value to the supplier depends in part on the prospects of the customer. Since the customer is likely better informed about its own prospects, credible disclosures of forward-looking information are relevant to the supplier's investment decision. I examine whether managers use financial disclosures to convey this information to suppliers. Using firm-level data of customer-supplier relationships, I find that supplier relationship-specific investments are positively related to a customer's disclosure of forward-looking information in segments and management forecasts. More importantly, I show that the loss of a relationship-specific supplier, which creates a need for a new supplier, strongly increases the likelihood of initiating forward-looking disclosures in the following period. I find that proprietary costs reduce the association between supplier investments and disclosure, although this result is sensitive to the measure of proprietary costs used. Overall, the findings suggest that disclosures are important beyond capital markets and play a role in supply chain contexts.

Influence of Intellectual Capital Investment, Risk, Industry Membership and Corporate Governance Mechanisms on the Voluntary Disclosure of Intellectual Capital by UK Listed Companies

<p>This research examines the cross-sectional effect of intellectual capital investment, financial measures of market and company specific risk, industry membership and corporate governance on the extent of voluntary disclosure of intellectual capital (VDIC) in a sample of 443 FTSE All Share Index company annual reports for the year 2003/2004. The extent of disclosure is measured by a disclosure index (DI) based on intellectual capital (IC) attributes included in the narratives and illustrations of the annual reports. The research predicts that agency costs are mitigated by VDIC and that the benefits of signalling IC may outweigh competitive and proprietary costs that may be more prevalent in innovative and technological companies; furthermore, that effective corporate governance measures enhance VDIC particularly in those companies found to have a higher level of intangible assets (IA) in their resource base. The results suggest that companies associated with less financial risk, reduced debt, higher levels of liquidity and accompanied by growth are characterised with higher levels of VDIC. Although less significant, the results on market risk indicate a positive influence on VDIC. Furthermore, the extent of VDIC in annual reports is enhanced when large companies operating in high-tech and innovative industries are characterised by investments in employees; in contrast, companies associated with research and development processes tend to be more secretive with respect to VDIC. The results suggest that companies that are able to maintain adequate governance systems through segregation of executive and non-executive duties and to a less extent through the presence of experienced non-executive directors exhibit higher levels of disclosure.</p>

Corporate Governance Mechanisms, Financial Risk, Industry Sector and Human Capital Investment as Determinants of Voluntary Disclosure of Intellectual Capital in UK Listed Firms

This research examines investment in human capital, financial risk, industry sector and corporate governance mechanisms as determinants of the voluntary disclosure of intellectual capital in a sample of 443 UK listed company annual reports for the year 2003/2004. This year precedes 2005 and the adoption of International Accounting Standards by European Union Member States thus providing the context for the study under reduced mandatory regulation. Voluntary disclosure is measured by an index based on intellectual capital attributes disclosed in the narratives and illustrations of the annual reports. The benefits of signalling intellectual capital are expected to outweigh proprietary costs due to these disclosures. These costs may be more prevalent in innovative and technological companies. Corporate governance mechanisms enhance voluntary disclosure and reduce information symmetry more specifically in those companies found to have higher levels of intangible assets in their resource base. The results suggest that companies associated with reduced financial risk and accompanied by growth are characterised with higher levels of voluntary disclosure of intellectual capital. Voluntary disclosure of intellectual capital is enhanced when large companies operating in high-tech and innovative industries are characterised by investments in human capital. The results suggest that companies that are able to maintain adequate governance systems through segregation of executive and non-executive duties and to a less extent through the presence of experienced non-executive directors exhibit higher levels of voluntary disclosure.

Proprietary costs of intellectual capital reporting: Malaysian evidence

Purpose – The purpose of this paper is to examine the relationship between intellectual capital (IC) performance (value-added intellectual coefficient (VAIC)) and company characteristics with IC disclosure (ICD) in Malaysian listed companies. Design/methodology/approach – Sample of the study is 68 biggest Malaysian companies listed in Malaysian Stock Exchange based on market capitalization in year 2006. The paper follows the classification of ICD by Huang et al. (2007), with three broad IC categories in 45 items. Content analysis was used to collect the IC information from the annual reports. Regression analysis was conducted for VAIC and its components. Log linear analysis was also conducted to cater the possible misspecification in the model. Findings – Results of the study show that VAIC is negatively related to ICD. Further classification of VAIC shows that intellectual capital efficiency and human capital efficiency are negatively related to ICD whilst structural capital efficiency is not related to ICD. Company size and leverage are found to be positively related to ICD. Research limitations/implications – Negative association between VAIC and ICD suggests that companies reduce ICD for competitive advantage reason which supports the proprietary cost theory. The findings of the study may provide some evidence to regulators to enhance the reporting practices of IC for the benefits of users of financial reporting in making relevant decisions. The focus should be given on the reporting of human capital items. Originality/value – This is the first paper to use IC framework by Huang et al. (2007). Consistency of findings with other studies using different IC framework can be compared for the choice of IC framework in future studies.

Firm Resources, Corporate Governance and the Disclosure of Intangible Assets

The paper investigates the determinants of intangible asset disclosure with reference to the interaction of heterogeneous asset and governance characteristics of firms. Specifically, it considers R&D intensity as a measure of asset heterogeneity and multiple proxies for the effectiveness of the firm’s corporate governance mechanisms and structures of accountability. Intellectual capital attributes are applied as the measure of disclosure quality and as the signalling mechanism through which management are able to inform markets of their competitive advantage. By applying the resource based view of the firm and signalling theory, the paper extends prior research on the determinants of intangibles disclosure through an analytical framework that examines the interaction of firm resources, corporate governance and intangibles disclosure. The theoretical framework combines the RBV of the firm in confirming intangibles as a necessary feature of disclosing firms’ asset base and signalling as the means with which management disclose their competitive advantage. The results of the analysis indicate a positive relationship between R&D intensity, complexity and scope of activity and the presence of quality signalling responses. Also, the separation of the roles of chair and non-executive director, complemented by experienced non-executive directors promote quality signalling through the disclosure of intellectual capital attributes. These findings support the view that corporate governance mechanisms are only effective when applied in combination. Governance mechanisms bring about transparency and accountability through disclosure of these intangibles despite the potential competitive losses. The lack of proprietary costs that might otherwise restrict disclosure might be attributed to competitors’ inability to imitate such intellectual capital resources and therefore their inability to duplicate such signals. The findings confirm the interaction between heterogeneous assets and governance mechanisms in the disclosure of intangibles as signalling mechanisms for management.

Theoretical foundation of IC disclosure strategies in high-tech industries

The purpose of this article is to examine the Intellectual Capital (IC) disclosure strategies of high-tech companies under different theoretical perspectives (agency, signalling and proprietary costs theories). According to the agency theory, the failure of traditional financial statements to report the ‘soft assets’ would lead knowledge-intensive firms (where the components of IC are structurally higher) to provide a higher level of disclosure in order to reduce the greater information asymmetries with external firm agents. However, because of the highly proprietary nature of IC information (proprietary costs theory) as well as the relevance of IC information to externally signal the key sources of superior quality of a company (signalling theory), different IC disclosure strategies may be adopted by managers of intellectual-capital-rich firms, depending on the particular motivations associated with firm-specific characteristics of these companies. Therefore, this study aims to better understand which theoretical framework under examination (if any) is best at interpreting the observed IC disclosure policies of high-tech companies. To this end, we deduce, and test, a set of hypotheses in accordance with the theoretical frameworks considered. The study also takes into account the effects of changes in the governmental regulation concerning non-financial information that occurred during the period examined. The empirical analysis is conducted on all Italian high-tech listed companies and based on longitudinal data (of 5 years: 2007–2011). By using longitudinal data and the population of all of the high-tech Italian companies, the analysis overcomes the well-known limitations of the sampling and the cross-sectional data that provide snapshot results. The findings reveal that the companies’ disclosure strategy primarily depends on the specific category of the IC information. In particular, the results suggest that the proprietary costs theory prevails in explaining the companies’ disclosure behaviour on internal IC information. The signalling theory prevails in the explanation of the communication strategies about external IC most likely to enhance investors’ confidence in the intangible key value drivers relating to relational capital. Finally, for companies examined, higher levels of ownership diffusion represent the primary incentive to disclose human capital information to reduce agency/monitoring costs (in presence of higher leverage) or signal to the market the superior quality (in presence of higher profitability). This article extends the existing empirical literature on IC disclosure behaviour in high-tech industries by analysing the disclosure strategies of high-tech companies under different theoretical perspectives including proprietary cost theory. In addition, the comprehensive regression model (with specific two-way interaction terms) used in this study expands on the extant approaches for the analysis of IC disclosure determinants allowing to capture some aspects that could be omitted when only the explanation variables taken separately are considered. This study has practical implications for various parties, such as regulators. It provides empirical evidence for the primary limits (relating to the proprietary costs) to an introduction of mandatory law requirements regarding the information on internal structure of IC. In particular, our findings prove that companies exposed to the threat of competitive disadvantages prefer not to provide – by formal channels, such as annual reports – additional internal IC information.

Goodwill Impairment Test Disclosures Under IAS 36: Disclosure Quality and its Determinants in Europe

The European Securities and Markets Authority (EMSA) criticizes the low disclosure quality and boilerplate disclosures in the accounting for goodwill among European listed companies, but it does not identify possible causes. Prior research also finds generally low compliance with disclosure requirements but usually does not consider disclosure quality or systematically examine the drivers of the observed levels of either compliance or disclosure quality. In this study, we analyze compliance and disclosure quality among European listed companies. We find low levels of compliance and disclosure quality and both are positively associated with firm size, goodwill intensity, enforcement and free float. In addition, disclosure quality is positively affected by board skills and company growth but negatively affected by proprietary cost. Our findings are of interest to regulators and enforcers who intend to increase the quality of disclosures. Moreover, we direct the attention of capital market participants to large differences in disclosure quality and the associated firm and governance characteristics.