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A discussion of the paper “The Quality of Neuer Markt Quarterly Reports—An Empirical Investigation” by Anne d'Arcy and Sonja Grabensberger
The International Journal of Accounting 38 (2003) 347 – 350
A discussion of the paper ‘‘The Quality of Neuer Markt Quarterly Reports—An Empirical Investigation’’ by Anne d’Arcy and Sonja Grabensberger Dimitrios C. Ghicas* Department of Accounting and Finance, Athens University of Economics and Business, 76 Patission Street, Athens 104 34, Greece
1. Contribution The objective of the study by d’Arcy and Grabensberger (2003) is to examine whether over the period 1999–2001 there has been an increase in the information disclosed in the quarterly reports of firms listed on the Neuer Markt of the Deutsche Boerse. The implicit assumption of the study is that more disclosure is equivalent to higher quality disclosure, which may be a necessary but not a sufficient condition. In general, quarterly reports provide more timely but less reliable financial information than annual or semi-annual reports because quarterly accounting information has not been verified by independent auditors. The quarterly information was compiled according to either IAS or the U.S. GAAP. Yet, the Deutsche Boerse, at some stage in the summer of 2000, decided to require that listed companies release quarterly information in a standardized format, acting in essence as a standard setter, because there were incidents of noncompliance with the GAAP selected by the listed firm. The empirical findings of the study suggest that over time there has been an increase in the level of disclosure and this increase is more pronounced for firms that have adopted IAS. The findings of the study show that in applying IAS, European companies were undergoing a learning process. This is an important but rarely mentioned issue in Europe, where IAS will become mandatory for all listed companies of EU countries in 2005. In addition, the study underscores the importance of the enforcing mechanism in the uniform application of the IAS standards, another issue that has not been resolved in Europe. * Tel.: +30-10-8203-300; fax: +30-10-8228-816. E-mail address: [email protected] (D.C. Ghicas). 0020-7063/03/$30.00 D 2003 University of Illinois. All rights reserved. doi:10.1016/S0020-7063(03)00041-4
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2. Methodological considerations The study pays particular attention to the construction of the disclosure index, the dependent variable of the study, and points out a number of limitations. A general limitation of this index is that it penalizes firms that do not disclose an item simply because they have nothing to disclose. A firm, for example, that has no business segments will not report any information about segments and the disclosure index measure will be lower than that of a firm that does have segments and reports the relevant information. Hence, the information disclosed by the former firm is not necessarily of lower quality than that of the latter. The disclosure index also does not consider the value relevance of the different items, since it may include both items that are value relevant as well as those not relevant for stock market participants. Hence, the value relevance of the disclosure index remains an open question and an examination of the association of the index with the stock returns following the disclosure of quarterly information would have been an additional dimension needed to substantiate the study. The study assumes that the primary benefit of increasing disclosure is a reduction in the information asymmetry component of the cost of capital. This argument was advanced by Leuz and Verrecchia (2000), who also tested it by using three surrogates for the information asymmetry component of the cost of capital. The three surrogates were the bid–ask spread, trading volume, and share-price volatility. Tests relying on these three measures would have provided evidence whether a decrease in the cost of capital occurs with increased disclosure. Alternatively, the authors could have measured directly the cost of capital by using a valuation model as in Botosan (1997) and used the measure from the valuation model to test whether increasing disclosure results in a reduction in the cost of capital. Either approach would measure the cost of capital with error but would be able to provide some support for the main assertion of this study. A recent trend in empirical research has been to place emphasis on graphs. This study appears to rely on this methodology to draw inferences. The proponents of this view argue that ‘‘a picture is equivalent to a thousand words,’’ but in building theories and developing scientific disciplines, the researcher makes probabilistic statements as to whether he/she rejects or fails to reject hypotheses. The graphs do not provide the researcher with the opportunity to measure the confidence level he/she places on the findings.
3. Empirical findings The empirical findings of the study suggest that over time there has been an increase in the level of disclosure and this increase is more pronounced for firms that have adopted IAS and less so for firms that have adopted U.S. GAAP. The authors appear to suggest that this improvement is due primarily to the standardization project of the Deutsche Boerse and not to reasons such as firm size and ‘‘time period since listing,’’ which act as surrogates for the ability of a firm to provide high-quality information. The reports are also filed timely (i.e., within 2 months following the end of the reporting period), but this appears to be a requirement of the
D.C. Ghicas / The International Journal of Accounting 38 (2003) 347–350
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Deutsche Boerse rather than a direct effect of the adoption of IAS or U.S. GAAP. Finally, firms that provide a full set of financial statements rather than a condensed version or reconciliation from national GAAP to IAS or U.S. GAAP have higher disclosure levels, although the number of firms using the condensed version and the reconciliation has drastically diminished over time. These comparisons between groups of firms are not based on statistical tests but only on observation of means and medians. Nonparametric statistics, which are appropriate for small samples, would have increased the internal validity of the findings. Another important finding is that firms reporting under U.S. GAAP have higher levels of disclosure than firms reporting under IAS, especially for the first 2 years examined. This is an issue that the study could have pursued further by providing the profile of each group of firms on certain dimensions, such as size, debt-to-equity ratio, auditor employed, industry composition, systematic risk, etc. It appears that these two groups of firms self-select themselves and one would like to know the reasons that motivate companies to choose one set of accounting standards over another. The auditors usually play an important role in the selection of the appropriate GAAP because they know the objectives of their client and the information that must be disclosed, even in the instances where direct audit work is not performed, and make appropriate recommendations.
4. The costs and benefits of increasing disclosure While the study places emphasis on one direct benefit of increasing disclosure, namely, the reduction in the information-asymmetry cost of capital, it remains silent on other benefits as well as costs of increasing disclosure. The studies by Bushee and Noe (2000) and Healy, Hutton, and Palepu (1999) show that institutional investors are attracted to firms with more forthcoming disclosure. Bushee and Noe also show that improvements in disclosure practices attract institutional investors that trade frequently and lead to significant increases in stock return volatility. High stock return volatility is potentially undesirable because it can increase the perceived riskiness of a firm and the cost of capital (Froot, Perold, & Stein, 1992). Thus, increasing disclosure could lead to higher cost of capital but the increase in the cost of capital arises from the behavior of institutional investors that trade frequently. Additional costs for the firms in the study could arise from a possible loss of their competitive advantage. Firms that feel the threat of competition have strong incentives, especially in the absence of auditors or strong enforcement mechanisms, to avoid disclosing certain items. Benefits could also arise for managers if their compensation package includes stock options, as increases in return volatility due to disclosure changes could lead to a higher value for the stock options. The work of Aboody and Kaznik (2001) indeed shows that managers make voluntary disclosure decisions to maximize the value of the stock option component of their compensation package. Healy et al. (1999) show that increases in disclosure ratings are associated with increases in analyst coverage. The variable, analyst coverage, provides information on the demand side of disclosure, while the disclosure index is primarily on the supply side. Analyst coverage attracts
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D.C. Ghicas / The International Journal of Accounting 38 (2003) 347–350
new investors, increases trading, and facilitates additional equity offerings. Hence, another benefit of higher disclosure is the ability to have easy access to capital markets. This benefit can be particularly important if the companies of the sample are young and fast growing.
5. Concluding remarks The preceding discussion has focused on a number of issues and difficulties that any researcher could face while conducting empirical research in the area of disclosure. The main difficulty, however, remains in the absence of a theory of disclosure that could guide the researcher. These comments do not alter the main finding of the study (i.e., there is an increasing level of quarterly disclosure over the time period covered in the study by the companies listed on the Neuer Markt of the Deutsche Boerse). It is perplexing, however, that the Neuer Markt of the Deutsche Boerse has decided to cease operations by the end of 2003 although listed companies were disclosing information according to U.S. GAAP or the IAS.
Acknowledgements The author acknowledges the suggestions of Demosthenis Hevas, Georgia Siougle, and Eleni Vrentzou.
References Aboody, D., & Kaznik, R. (2000). CEO stock option awards and the timing of corporate voluntary disclosures. Journal of Accounting and Economics, 29, 73 – 100. Botosan, C. (1997). Disclosure level and the cost of equity capital. Accounting Review, 72, 323 – 349. Bushee, B. J., & Noe, C. F. (2000). Corporate disclosure practices, institutional investors, and stock return volatility. Journal of Accounting Research, 38, 171 – 202 (Supplement). d’Arcy, A., & Grabensberger, S. (2003). The quality of Neuer Markt quarterly reports—An empirical investigation. International Journal of Accounting, 38, 329 – 346. Froot, K., Perold, A., & Stein, J. (1992). Shareholder trading practices and corporate investment horizons. Journal of Applied Corporate Finance, 5, 42 – 58. Healy, P. M., Hutton, A. P., & Palepu, K. (1999). Stock performance and intermediation changes surrounding sustained increases in disclosure. Contemporary Accounting Research, 16, 485 – 520. Leuz, C., & Verrecchia, R. E. (2000). The economic consequences of increased disclosure. Journal of Accounting Research, 38, 91 – 124.
A discussion of the paper ‘‘The Quality of Neuer Markt Quarterly Reports—An Empirical Investigation’’ by Anne d’Arcy and Sonja Grabensberger Dimitrios C. Ghicas* Department of Accounting and Finance, Athens University of Economics and Business, 76 Patission Street, Athens 104 34, Greece
1. Contribution The objective of the study by d’Arcy and Grabensberger (2003) is to examine whether over the period 1999–2001 there has been an increase in the information disclosed in the quarterly reports of firms listed on the Neuer Markt of the Deutsche Boerse. The implicit assumption of the study is that more disclosure is equivalent to higher quality disclosure, which may be a necessary but not a sufficient condition. In general, quarterly reports provide more timely but less reliable financial information than annual or semi-annual reports because quarterly accounting information has not been verified by independent auditors. The quarterly information was compiled according to either IAS or the U.S. GAAP. Yet, the Deutsche Boerse, at some stage in the summer of 2000, decided to require that listed companies release quarterly information in a standardized format, acting in essence as a standard setter, because there were incidents of noncompliance with the GAAP selected by the listed firm. The empirical findings of the study suggest that over time there has been an increase in the level of disclosure and this increase is more pronounced for firms that have adopted IAS. The findings of the study show that in applying IAS, European companies were undergoing a learning process. This is an important but rarely mentioned issue in Europe, where IAS will become mandatory for all listed companies of EU countries in 2005. In addition, the study underscores the importance of the enforcing mechanism in the uniform application of the IAS standards, another issue that has not been resolved in Europe. * Tel.: +30-10-8203-300; fax: +30-10-8228-816. E-mail address: [email protected] (D.C. Ghicas). 0020-7063/03/$30.00 D 2003 University of Illinois. All rights reserved. doi:10.1016/S0020-7063(03)00041-4
348
D.C. Ghicas / The International Journal of Accounting 38 (2003) 347–350
2. Methodological considerations The study pays particular attention to the construction of the disclosure index, the dependent variable of the study, and points out a number of limitations. A general limitation of this index is that it penalizes firms that do not disclose an item simply because they have nothing to disclose. A firm, for example, that has no business segments will not report any information about segments and the disclosure index measure will be lower than that of a firm that does have segments and reports the relevant information. Hence, the information disclosed by the former firm is not necessarily of lower quality than that of the latter. The disclosure index also does not consider the value relevance of the different items, since it may include both items that are value relevant as well as those not relevant for stock market participants. Hence, the value relevance of the disclosure index remains an open question and an examination of the association of the index with the stock returns following the disclosure of quarterly information would have been an additional dimension needed to substantiate the study. The study assumes that the primary benefit of increasing disclosure is a reduction in the information asymmetry component of the cost of capital. This argument was advanced by Leuz and Verrecchia (2000), who also tested it by using three surrogates for the information asymmetry component of the cost of capital. The three surrogates were the bid–ask spread, trading volume, and share-price volatility. Tests relying on these three measures would have provided evidence whether a decrease in the cost of capital occurs with increased disclosure. Alternatively, the authors could have measured directly the cost of capital by using a valuation model as in Botosan (1997) and used the measure from the valuation model to test whether increasing disclosure results in a reduction in the cost of capital. Either approach would measure the cost of capital with error but would be able to provide some support for the main assertion of this study. A recent trend in empirical research has been to place emphasis on graphs. This study appears to rely on this methodology to draw inferences. The proponents of this view argue that ‘‘a picture is equivalent to a thousand words,’’ but in building theories and developing scientific disciplines, the researcher makes probabilistic statements as to whether he/she rejects or fails to reject hypotheses. The graphs do not provide the researcher with the opportunity to measure the confidence level he/she places on the findings.
3. Empirical findings The empirical findings of the study suggest that over time there has been an increase in the level of disclosure and this increase is more pronounced for firms that have adopted IAS and less so for firms that have adopted U.S. GAAP. The authors appear to suggest that this improvement is due primarily to the standardization project of the Deutsche Boerse and not to reasons such as firm size and ‘‘time period since listing,’’ which act as surrogates for the ability of a firm to provide high-quality information. The reports are also filed timely (i.e., within 2 months following the end of the reporting period), but this appears to be a requirement of the
D.C. Ghicas / The International Journal of Accounting 38 (2003) 347–350
349
Deutsche Boerse rather than a direct effect of the adoption of IAS or U.S. GAAP. Finally, firms that provide a full set of financial statements rather than a condensed version or reconciliation from national GAAP to IAS or U.S. GAAP have higher disclosure levels, although the number of firms using the condensed version and the reconciliation has drastically diminished over time. These comparisons between groups of firms are not based on statistical tests but only on observation of means and medians. Nonparametric statistics, which are appropriate for small samples, would have increased the internal validity of the findings. Another important finding is that firms reporting under U.S. GAAP have higher levels of disclosure than firms reporting under IAS, especially for the first 2 years examined. This is an issue that the study could have pursued further by providing the profile of each group of firms on certain dimensions, such as size, debt-to-equity ratio, auditor employed, industry composition, systematic risk, etc. It appears that these two groups of firms self-select themselves and one would like to know the reasons that motivate companies to choose one set of accounting standards over another. The auditors usually play an important role in the selection of the appropriate GAAP because they know the objectives of their client and the information that must be disclosed, even in the instances where direct audit work is not performed, and make appropriate recommendations.
4. The costs and benefits of increasing disclosure While the study places emphasis on one direct benefit of increasing disclosure, namely, the reduction in the information-asymmetry cost of capital, it remains silent on other benefits as well as costs of increasing disclosure. The studies by Bushee and Noe (2000) and Healy, Hutton, and Palepu (1999) show that institutional investors are attracted to firms with more forthcoming disclosure. Bushee and Noe also show that improvements in disclosure practices attract institutional investors that trade frequently and lead to significant increases in stock return volatility. High stock return volatility is potentially undesirable because it can increase the perceived riskiness of a firm and the cost of capital (Froot, Perold, & Stein, 1992). Thus, increasing disclosure could lead to higher cost of capital but the increase in the cost of capital arises from the behavior of institutional investors that trade frequently. Additional costs for the firms in the study could arise from a possible loss of their competitive advantage. Firms that feel the threat of competition have strong incentives, especially in the absence of auditors or strong enforcement mechanisms, to avoid disclosing certain items. Benefits could also arise for managers if their compensation package includes stock options, as increases in return volatility due to disclosure changes could lead to a higher value for the stock options. The work of Aboody and Kaznik (2001) indeed shows that managers make voluntary disclosure decisions to maximize the value of the stock option component of their compensation package. Healy et al. (1999) show that increases in disclosure ratings are associated with increases in analyst coverage. The variable, analyst coverage, provides information on the demand side of disclosure, while the disclosure index is primarily on the supply side. Analyst coverage attracts
350
D.C. Ghicas / The International Journal of Accounting 38 (2003) 347–350
new investors, increases trading, and facilitates additional equity offerings. Hence, another benefit of higher disclosure is the ability to have easy access to capital markets. This benefit can be particularly important if the companies of the sample are young and fast growing.
5. Concluding remarks The preceding discussion has focused on a number of issues and difficulties that any researcher could face while conducting empirical research in the area of disclosure. The main difficulty, however, remains in the absence of a theory of disclosure that could guide the researcher. These comments do not alter the main finding of the study (i.e., there is an increasing level of quarterly disclosure over the time period covered in the study by the companies listed on the Neuer Markt of the Deutsche Boerse). It is perplexing, however, that the Neuer Markt of the Deutsche Boerse has decided to cease operations by the end of 2003 although listed companies were disclosing information according to U.S. GAAP or the IAS.
Acknowledgements The author acknowledges the suggestions of Demosthenis Hevas, Georgia Siougle, and Eleni Vrentzou.
References Aboody, D., & Kaznik, R. (2000). CEO stock option awards and the timing of corporate voluntary disclosures. Journal of Accounting and Economics, 29, 73 – 100. Botosan, C. (1997). Disclosure level and the cost of equity capital. Accounting Review, 72, 323 – 349. Bushee, B. J., & Noe, C. F. (2000). Corporate disclosure practices, institutional investors, and stock return volatility. Journal of Accounting Research, 38, 171 – 202 (Supplement). d’Arcy, A., & Grabensberger, S. (2003). The quality of Neuer Markt quarterly reports—An empirical investigation. International Journal of Accounting, 38, 329 – 346. Froot, K., Perold, A., & Stein, J. (1992). Shareholder trading practices and corporate investment horizons. Journal of Applied Corporate Finance, 5, 42 – 58. Healy, P. M., Hutton, A. P., & Palepu, K. (1999). Stock performance and intermediation changes surrounding sustained increases in disclosure. Contemporary Accounting Research, 16, 485 – 520. Leuz, C., & Verrecchia, R. E. (2000). The economic consequences of increased disclosure. Journal of Accounting Research, 38, 91 – 124.