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The quality of Neuer Markt quarterly reports—an empirical investigation
The International Journal of Accounting 38 (2003) 329 – 346
The quality of Neuer Markt quarterly reports—an empirical investigation$ Anne d’Arcy a,*, Sonja Grabensbergerb a
European Accounting and Disclosure Regulation, Corporate Center Controlling, Deutsche Bank AG, D-60325, Frankfurt am Main, Germany b Group Account, Siemens VDO Automotive AG, D-65824 Schwalbach, Germany
Abstract When compared with its prior performance, the year 2001 is not one of the best years for the Neuer Markt. The Neuer Markt’s reputation has been marred by the practice of several companies on the exchange that have published misleading information in the form of incomplete annual and quarterly data. In this study, we examine the quality of Neuer Markt quarterly reports by concentrating on the disclosure level of 47 Neuer Markt companies’ reports for the third quarter of 1999, 2000, and 2001. To enable making comparisons, we have established four disclosure indexes that measure each report’s compliance with the Neuer Markt Rules and Regulations (NM Rules and Regulations) as well as with International Accounting Standards (IAS) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) interim reporting standards. We then attempt to find typical attributes of Neuer Markt enterprises that provide high or low level of disclosure accounting information in their quarterly reports. The results demonstrate that the level of disclosure has increased over time, partly in response to additional enforcement. In this regard, the quarterly reports standardization project of Deutsche Boerse is an important landmark in satisfying investors’ information needs. D 2003 University of Illinois. All rights reserved. Keywords: Deutsche Boerse; Neuer Markt Rules and Regulations; International Accounting Standards; U.S. Generally Accepted Accounting Principles
$
This paper was presented at the International Accounting Summer Conference CIERA Symposium held in Champaign, IL in March 2002. * Corresponding author. E-mail addresses: [email protected] (A. d’Arcy), [email protected] (S. Grabensberger). 0020-7063/03/$30.00 D 2003 University of Illinois. All rights reserved. doi:10.1016/S0020-7063(03)00040-2
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1. Introduction Despite the recent market turndown, Germany’s Neuer Markt, launched in March 1997, was considered to be the most successful stock market for growth companies in Europe in terms of both market capitalization and number of listings (Deutsche Bo¨rse, 2001a). This success can primarily be accounted for by its substantially stricter disclosure and listing requirements compared with other German market segments.1 However, even if the Neuer Markt already boasts some of the tightest regulations in Europe, the general sell-off in technology and Internet stocks, a string of profit warnings, insider-dealing investigations, and insolvencies have shaken investors’ confidence and prices have fallen by more than 90% from its peak reached in March 2000 to its all-time low in 2002 (Wall Street Journal Europe, 2000). This sharp setback in stock prices was a shock not only to many inexperienced retail investors who have for the first time realized a massive loss exposure (Benoit, 2001) but also to institutional investors who seem to be surprised by the free fall of prices. In troubled financial markets, people are eager to seek out plausible explanations, and in some cases, people even find scapegoats. One viable starting point for this quest is questioning what type of information was available for investors and whether or not a better quantity or quality of information could have enhanced investors’ decisions. Quarterly reports are important sources of information, and companies listed on Neuer Markt are required to publish such reports and to prepare their accounts in accordance with either the International Accounting Standards (IAS) or the U.S. Generally Accepted Accounting Principles (U.S. GAAP) [7.1 Neuer Markt Rules and Regulations (NM Rules and Regulations)]. However, quarterly reports of several Neuer Markt companies were criticized as failing to meet investors’ information needs (Maier & Herr, 2000). Important information was either missing or of poor quality. One major criticism is that, even if the rules are heavily influenced by regulation of Nasdaq and the U.S. Securities Exchange Commission (SEC), they lack a comparable enforcement mechanism. In fact, the Neuer Markt listing requirements are set in a rulebook that clearly spells out requirements for the issuer.2 Deutsche Boerse acts as both the standard setter and the enforcement institution at the same time, and there is no government-based supervisor responsible for assuring the quality of quarterly reports. Moreover, Glaum and Street (2002) show that there was considerable noncompliance with IAS and U.S. GAAP disclosure rules in the year 2000 financial statements of 100 Neuer Markt companies. 1
See Financial Times (2001). The NM Rules and Regulations can be downloaded at http://www.deutscheboerse.com/nm. For the analysis, we take the NM Rules and Regulations as of May 21, 2001. 2 The shares are admitted under public law to the Second Segment (Geregelter Markt) with relatively low publication requirements like half-year summaries. Additionally, for the admission under private law to the trading segment ‘‘Neuer Markt,’’ the rules and regulations must be accepted by the issuer. The Executive Board of the Deutsche Boerse can reject the application if the admission criteria of registration conditions are not fulfilled. Moreover, it can terminate the admissions to the Neuer Markt if the issuer does not adhere to the requirements connected with the admission. See Deutsche Boerse Information Folder, Section 2.1, version January 1, 2001. In connection with the new delisting rule, the Frankfurt court stated that the NM Rules and Regulations could be interpreted as general trade conditions, but they showed some particularities. See LG Frankfurt, decision from August 15, 2001—3-13 O 110/01 (nrkr).
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In this study, we concentrate on the disclosure level of quarterly reports of 47 Neuer Markt companies for the third quarter of 1999, 2000, and 2001. We begin by briefly describing in Section 2 the interim reporting standards of the Neuer Markt, IAS, and U.S. GAAP. Section 3 discusses certain approaches that measure the quality of interim reports by disclosure levels. We then compare disclosure indexes that measure the report’s compliance with the NM Rules and Regulations as well as with IAS and U.S. GAAP interim reporting standards. Next, we try to discover typical attributes of Neuer Markt companies that provide high or low level accounting information in their quarterly reports by investigating the correlations between the disclosure level and certain criteria like market capitalization and the time of existence in the Neuer Markt. Section 4 demonstrates that the level of disclosure has increased over time. An additional enforcement mechanism added in 2000 has especially improved reporting quality. In this regard, the quarterly reports standardization project of Deutsche Bo¨rse (2001b) is an important landmark in satisfying investors’ information needs. Section 5 concludes the paper.
2. Interim reporting standards 2.1. NM Rules and Regulations Four years after its launch in March 1997, more than 340 companies were listed on Neuer Markt, 56 of which were headquartered outside Germany.3 The NM Rules and Regulations require the publication of quarterly reports that follow either IAS or U.S. GAAP (d’Arcy & Leuz, 2000). In both cases, Neuer Markt-listed companies are required to publish quarterly reports in both German and English. These reports must contain financial statements and a notes section, the most important components of which are income statement, cash flow statement, and net income or loss per share. For each figure, the previous year’s comparative figure for the corresponding period shall be given (7.1.2 NM Rules and Regulations). The following notes are to be made in the explanatory section, each with comparable figures from the previous year (7.1.3 NM Rules and Regulations): 1. 2. 3. 4. 5. 6.
breakdown of revenues, remarks to the order situation (order backlog), presentation of the development of costs and prices, R&D activities, specification for the investment activities, presentation of personnel changes in the company’s Board of Management Directors or supervisory bodies, 7. explanations of shares held by the company and subscription rights of officers and employees, 3
See Deutsche Bo¨rse (2001a). See also Leuz (2003, pp. 450 – 452) for a brief description of the Neuer Markt.
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8. explanation regarding distribution of interim dividends,4 and 9. number of employees. If a Neuer Markt-listed company published its preceding annual report on a consolidated basis, then the quarterly report consisting of the financial statements and the explanatory notes are to be prepared on a consolidated basis too (7.1.4 NM Rules and Regulations). In Article 7.1.7 of the NM Rules and Regulations, it is stated that the quarterly report has to be transmitted immediately following its completion and within at least 2 months of the end of the relevant reporting period. In this case, we analyze the Neuer Markt-listed companies that have electronically submitted the quarterly report within the prescribed period.5 Furthermore, at the request of the company, Deutsche Boerse may, under some circumstances, permit a reconciliation of national accounting principles to IAS or U.S. GAAP (7.3.2 NM Rules and Regulations). Deutsche Boerse comments that this reconciliation statement must in its material aspects have the format of the U.S. GAAP reconciliation statement. From the viewpoint of Deutsche Boerse, this reconciliation statement can be regarded to be the minimum reporting to be presented. 2.2. Interim financial reporting according to IAS 34 IAS 34 sets detailed rules for interim reporting in order to make sure that investors are informed of the latest financial news of a company. Quarterly reports should preferably focus on new activities, events, and circumstances that have occurred since the publication of the latest annual financial statements. Thus, IAS 34 has softened the presentation of quarterly reports compared with annual financial statements (Epstein & Mirza, 1999, p. 651). A quarterly report in accordance with IAS 34 must contain financial statements and explanatory notes. The standard mandates that the following financial statements components be presented either in full (IAS 34.5) or in a condensed format,6 each with comparable figures for the previous year (IAS 34.20): balance sheet, income statement, EPS (basic/diluted) (IAS 34.11), cash flow statement, and statement of changes in stockholder’s equity.7
4
In some countries, it is allowed to distribute interim dividends, whereas this is forbidden to German public companies. See Section 59 AktG. For this reason, only non-German companies were analyzed whether this specification was given or not. 5 The publication period postulated in the NM Rules and Regulations does overrule neither the IAS recommended 60-day period [IAS 34.1 (b)] nor the U.S. GAAP required 45-day period (Form 10-Q, General Instructions A.1.) because it is to be regarded as special rule of Neuer Markt-listed companies. 6 If a company presents its quarterly report in a ‘‘condensed format,’’ then IAS 34.10 requires that, at a minimum, those ‘‘condensed financial statements’’ should include each of the headings and the subtotals that were included in the company’s most recent annual financial statement. 7 According to IAS 34.8c, the companies can choose between the presentation of a statement of changes in stockholders’ equity and a statement of comprehensive income. None of the Neuer Markt-listed companies chose the possibility of showing a comprehensive income statement. Thus, we only examine these companies whether they present the statement of changes in stockholders’ equity or not.
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The explanatory notes that accompany financial statements state the minimum disclosures to be made, as outlined below (IAS 34.16): 1. a statement that the same accounting policies and methods are applied in the quarterly report compared with the most recent annual report, 2. comments about seasonality or cyclicality of interim operations, 3. nature and magnitude of significant items affecting interim results that are unusual because of nature, size, or incidence, 4. nature and quantum of changes in estimates, if affecting the actual report, 5. issuance, repurchases, and repayments of debt and equity securities, 6. dividends paid, 7. revenue and operating results for business segments or geographical segments, which represent the company’s primary mode of segment reporting: If a company is obliged to prepare a ‘‘complete set of financial statements,’’ then it shall follow IAS 14 (Price Waterhouse Coopers (PWC), 1999, p. 5). 8. significant events occurring subsequent to the end of the reporting period, 9. changes in the composition of companies to be consolidated, and 10. changes in contingent liabilities or assets. IAS 34.14 requires consolidated financial statements if the preceding annual financial statements were presented on a consolidated basis. 2.3. Interim financial reporting according to U.S. GAAP The basic objective of the U.S. GAAP interim reporting is to provide investors and others with timely information as to the progress of the enterprise. The timeliness of presentation may be partially offset by a modification in detail in the information provided (APB 28.9 and 30) (Epstein & Mirza, 1999, p. 757). As a result, using APB 28 as a guideline allows a company to present quarterly reports either in a ‘‘summarized form’’ or as a ‘‘complete set of financial statements.’’ APB 28 represents the general guideline among other SFAS, FASB Interpretations, and for certain practical aspects the regulation S-X (Delaney, Epstein, Adler, & Foran, 2000, p. 757). If a Neuer Markt company has decided to prepare its quarterly report according to U.S. GAAP, it would have to show the following financial statements components, each with comparable preceding year’s figures (APB 28.2 and 33): balance sheet, income statement,8 cash flow statement, segment report (for condensed form overview only) (APB 28.30), and statement of changes in stockholders’ equity.9 8 APB 28 requires for the income statement the presentation of significant items only. To close this interpretative gap, the NM Rules and Regulations requires explicitly an entire income statement. This was also clarified by the Deutsche Bo¨rse by the market circular on Structured Quarterly Reports. 9 For 1999 and 2000, none of the Neuer Markt-listed companies chose the possibility of showing a comprehensive income statement. Thus, we only examine these companies whether they present the statement of changes in stockholders’ equity or not.
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The type and scope of the complete set is determined by the most recent annual report.10 For both formats, the following disclosure should be reported as a minimum (APB 28.30) (Kieso & Weygandt, 2001, p. 1397): 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
sales or gross revenues, provisions for income taxes, extraordinary items, cumulative effect of a change in accounting principles or practices, net income, EPS (basic), EPS (diluted), seasonal revenue, costs, or expenses, significant changes in estimates or provisions for income taxes, disposal of a segment of a business and extraordinary, unusual, or infrequently occurring items, 11. contingent items, 12. changes in accounting principles or estimates, and 13. significant changes in financial positions. Quarterly reports according to U.S. GAAP shall be based on the same accounting policies and practices used by the company in the preparation of its most recent annual report. Three companies of our sample are dual listed on the Neuer Markt as well as on Nasdaq. They use the Form 10-Q instead of a quarterly report, which was accepted by Deutsche Boerse.
3. Methodology and research data 3.1. Methodology: developing disclosure indexes Corporate finance theory predicts that companies endogenously optimize disclosure policy in order to maximize firm value. This choice involves trading off the reduction in the information asymmetry component of the cost of capital that results from increased disclosure quality (see Leuz & Verrecchia, 2000; Verrecchia, 1983; for an empirical literature overview, see Core, 2001; Healy & Palepu, 2001). For firms with low growth opportunities, a minimum disclosure may be of sufficiently high quality because those firms have no need for external finance and therefore are not influenced by the cost of new equity capital.11 For firms with high growth opportunities—like Neuer Markt companies—information asymmetry is high and some reduction through voluntary disclosure would seem optimal (Core, 2001, pp. 2–3). 10
This is the interpretation of KPMG regarding Neuer Markt-listed companies preparing the quarterly reports under U.S. GAAP. See also KPMG (1999, p. 181). 11 However, there is some empirical evidence that disclosure quality also influences the cost of debt (Sengupta, 1998).
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Accordingly, a number of empirical studies suggest a link between cost of equity capital and disclosure (Botosan & Plumlee, 2000, p. 3). To accept this connection, we first have to define the disclosure level as an indicator for reporting quality. Recent empirical disclosure literature suggests that mandatory disclosure is enforced and therefore does not have to be included in a disclosure quality index. This assumption does not hold for the Neuer Markt because one major criticism concentrates on the noncompliance of some issuers with existing rules. Furthermore, the companies have to report in accordance with the NM Rules and Regulations as well as those of either IAS or U.S. GAAP. Accordingly, we have to consider different systems. We find a related research question in the comparison of national accounting systems by disclosure levels. In the 1970s, Barrett (1975, 1976, 1977) developed an ‘‘index of disclosure,’’ which measured the complexity and adequacy of accounting information for certain national accounting systems by investigating the disclosure of several annual reports. The presence of 17 ‘‘items of information’’ in each report determines the index. As a result, companies, especially American and British ones, show high values, whereas the continental European firms indicate relatively low degrees with France at the bottom.12 Also, in the 1970s, Choi (1973a, 1973b, 1974) published three studies about the relation of external environmental factors to the capital market influence on accounting and the quality of financial reporting practices. Similar to Barrett’s method, Choi measures the degree by a ‘‘level of disclosure’’ that is based on 36 ‘‘items of information.’’ Belkaoui (1983) uses a partly related concept that evaluates national accounting systems by a ‘‘reporting and disclosure adequacy index’’ based on the Price Waterhouse (1979) database on accounting practices. The index is calculated by summing the ordinal categories of all items for each country, which includes disclosure as well as measurement practices. The enclosed test of significance does not prove a strong relation between this index and several environmental factors. Furthermore, Belkaoui and Maksy (1985) test the relation between the ‘‘reporting and disclosure adequacy index’’ and the concept of the ‘‘welfare of the common man.’’ As in the earlier study, they did not verify the existence of a significant dependence. Nowadays, several databases of annual reports provide information on whether or not several disclosure items are included.13 The most recent study from Glaum and Street (2002) on the compliance with the disclosure requirements of Neuer Markt companies derived the dependent variable from a checklist that coded disclosure items as disclosed, not disclosed, or not applicable. Glaum and Street calculated a disclosure compliance index for each company by dividing the total number of required disclosures by the number of applicable disclosures. The above-noted studies define the disclosure level by adding up the number of disclosure items. Similarly, we establish disclosure levels by defining items of information that should 12
In his analysis from 1975, Barrett makes use of the reports of the 15 biggest enterprises for each country only. In the later studies form 1976 and 1977, the database considers 103 reports from the financial years 1963 – 1972. 13 See, for example, the AIMR reports (http://www.aimr.org).
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be included in the interim report following the related standards as described in Section 2. For each level, we compute 1999, 2000, and 2001 numbers to investigate developments. a. The first index, FINANCIALS, is noted by one if all parts of an interim report are present, namely the income statement, the balance sheet, the cash flow statement, and the earnings per share figure, each with comparable preceding year’s figures. This measure is independent from type of accounting standards employed.14 b. The second index, NM, indicates compliance with explicit disclosure regulations of the Neuer Markt as described in Section 2.1. c. The third index, IAS, scales the compliance with IAS 34 disclosure rules for companies that follow IAS. d. The fourth index, US, shows the conformity with U.S. GAAP interim reporting standards as described in Section 2.3. e. Finally, we establish the index ALL, which describes the overall disclosure level for all companies under review on a percent basis. The indexes FINANCIALS, NM, and either IAS or US are accumulated while eliminating duplicate information, e.g., earnings per share figures that are part of FINANCIALS and US. 3.2. Limitations We are aware of the limitations of this research approach. The indexes are defined as simple sums. Because all items of information are equally weighted, important items may be swamped by trivial ones. Consistent with other approaches, we measure how well the reports conform to the related standards. This method may not provide a strong indicator of the quality of accounting numbers that are not public information. Although we view disclosure quality in a narrow sense, the results offer an opportunity to gain new insights into the level of information that companies publish on a quarterly basis. Thus, these results cannot be interpreted as a complete measure of compliance with interim reporting standards. Although Glaum and Street (2002) differentiate between ‘‘not applicable’’ and ‘‘not disclosed’’ data and calculate an overall compliance index, they also use publicly available information and are therefore not able to differentiate between missed disclosure and not satisfying certain criteria. Thus, a disclosure index can be interpreted only in a relative sense, and we have established a 3-year comparison to analyze possible developments. 3.3. Research data We use only a sample of the 174 companies listed on the Neuer Markt at the end of October 1999 that were required to submit quarterly reports.15 Only companies that published 14 We do not include the statement of changes in stockholders’ equity in this figure because it is not required in all cases. However, FINANCIALS do not provide us the full information on the compliance regarding the components of an interim report for companies that tend to follow IAS. 15 All Neuer Markt-listed companies that receive listing authorization during the accounting period are obliged to provide a quarterly report. This is implicitly stated in 7 NM Rules and Regulations.
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Table 1 Accounting standards used and usage of reconciliation 1999
2000
2001
U.S. GAAP IAS Total U.S. GAAP IAS Total U.S. GAAP IAS Total
Full
Reconciliation
Total
23 13 36 26 19 45 25 21 46
5 6 11 1 1 2 1 0 1
28 19 47 27 20 47 26 21 47
the six monthly and the third quarter reports for 1999 were selected for the initial sample. We deleted four firms that we could not identify the accounting regime used, and based on internal Deutsche Bo¨rse advice, market capitalization was either less than 80 million or greater than 3 billion euros (Deutsche Bo¨rse, 1999). We further reduce this sample for 2000 by two companies due to insolvency and merger. In 2001, five more companies of the original sample were delisted. We use the sample of 47 Neuer Markt companies to compare quarterly reports of the third quarter of 1999 with those of the third quarter of 2000 and 2001. The accounting standards adopted and the extent of using reconciliation (instead of a full set of financial statements) for the sample of 47 companies is presented in Table 1.
4. Results 4.1. Disclosure levels Fig. 1 shows the frequencies for the FINANCIALS index for 1999, 2000, and 2001. In 1999, only 20 companies (43%) show all elements of an interim report with an average of 6.62 out of a maximum of 8 elements shown. Nearly three-quarters of the firms fulfill this
Fig. 1. Frequencies of FINANCIALS.
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Fig. 2. Frequencies of NM.
requirement in 2000, with an average of 7.32. The S.D. decreases from 1.38 to 1.12. In 2001, all companies show the basic elements of an interim report based on the formats required by Deutsche Bo¨rse. It appears that standardization of quarterly reports has succeeded in enforcing certain levels of disclosure. In 1999 and 2000, the comparable figures in the preceding year are missing in some cases. One company does not provide a cash flow statement in 2000 (three in 1999). In 6 cases, the EPS figure is missing in 2000 compared with 10 in 1999. Six companies do not present a balance sheet in 2000 (11 in 1999). This is likely to be due to the fact that the 1999 version of the NM Rules and Regulations did not explicitly require a balance sheet although it is required by both IAS and U.S. GAAP. Fig. 2 shows the frequencies that indicate compliance with the NM Rules and Regulations. Some rules are only applicable under certain conditions, e.g., disclosure about changes in the boards. It is therefore not surprising that only one company reaches the maximum sum of nine (in 2001). Relevant information is often missing: eight companies do not show a breakdown of their revenues in 1999 (only one in 2000); three of the companies that publish their quarterly reports on Form 10-Q ignored the Neuer Markt disclosure requirements. However, the index has increased by about 21% from 1999 and 2000 and by 19% from 2000 to 2001. On average, sample companies show 3.81 items of information (median = 4) in 1999, 4.62 (median = 4) in 2000, and 5.51 (median = 6) in 2001. This change was accompanied by a
Fig. 3. Frequencies of IAS.
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Fig. 4. Frequencies of US.
more moderate increase in the S.D. from 1.35 in 1999 to 1.78 in 2001. There is nevertheless important information that remain undisclosed, e.g., major investments or R&D activities. Forty-six companies provided disclosure on their own shares in 2001 while there were only two companies in 2000, whereas no company disclosed own share information in 1999. The same is true with the IAS index (Fig. 3). Two companies (of 19) in 1999 and one (of 20) in 2000 do not provide even one item of information following IAS 34 requirements. Segment information was not disclosed for more than the 60% of the companies under review, although this effect may be traced back to IAS 14, which did not require segment information in all cases. However, the 18 companies that had provided segment information in 2001 represents a significant increase when compared with 3 in 1999 and 8 in 2000. The mean index increases from 1.68 in 1999 to 2.45 (with an increasing S.D. from 0.95 to 1.32). In 2001, the mean reaches 3.19, an increase of 30%, while the median increases from 2 to 3. The S.D. remains almost unchanged at 1.36. For the US index (Fig. 4), not all of the 13 items are disclosed by all companies even if they report according to the detailed SEC regulations Form 10-Q as shown by the high S.D. of 2.06 in 2000 and 1.95 in 1999, which declines to 1.53 in 2001. The increase of the index mean from 4.39 in 1999 (4.26 in 2000) to 5.12 in 2001 is not as high as the increase for other
Fig. 5. Mean development.
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Fig. 6. ALL index: histogram of frequencies.
indexes. Essential information, such as basic earnings per share figures, are not given by eight firms for 2000 (six for 1999), whereas all companies provide earnings per share information in 2001; despite the fact that almost all companies may have a dilutive effect on the earnings per share figure from their contribution plans, dilutive earnings per share numbers are presented by 19 companies for 2001, 8 for 2000, and 9 for 1999. In summary, except for the basic parts in 2001, the disclosure indexes are not as high as would be expected. However, the relative disclosure levels have been increasing (see Fig. 5) over the 3 years studied. The IAS disclosure level grows at over 30% per year, whereas the US disclosure level is more constant. These conclusions are confirmed by analyzing the ALL index for 1999, 2000, and 2001 (see Fig. 6). The overall disclosure level for all companies increased up from 48.81% to 56.13% and 63.42%, an increase of 15% in 1 year, while the S.D. remained almost constant. The second year shows an increase of 13% with a lower S.D. of 0.83. 4.2. Correlations We looked for correlated patterns to characterize how a company with a high or low disclosure level can be characterized. The first important attribute may be the accounting principles used. U.S. GAAP is enforced for three companies in this study because they are
Table 2 ALL IAS and ALL US
n Mean (%) Median (%) S.D. Minimum (%) Maximum (%)
ALL IAS 1999
ALL US 1999
ALL IAS 2000
ALL US 2000
ALL IAS 2001
ALL US 2001
19 46.30 47.22 0.0996 24.07 62.96
28 50.51 48.98 0.1057 32.04 71.48
20 53.26 52.78 0.1017 31.94 70.37
27 58.27 58.06 0.1051 35.74 85.93
21 63.67 66.67 0.0912 48.15 77.78
26 63.22 62.22 0.0798 47.78 82.96
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Table 3 Influence of full format versus reconciliation 1999 2000 2001
Full accounts Reconciliation Full accounts Reconciliation Full accounts Reconciliation
n
Mean (%)
Median (%)
Minimum (%)
Maximum (%)
S.D.
36 11 45 2 46 1
49.94 45.10 56.53 47.31 63.53 58.15
50.56 42.78 55.56 47.31 62.22 n.a.
24 29 32 44 48 58
71 59 86 51 83 58
0.10644 0.09154 0.10586 0.05369 0.08470 n.a.
listed on a US exchange. By comparing the index ALL in the disclosure level for companies that follow IAS and those that follow U.S. GAAP, we find the disclosure level of these U.S. GAAP companies to be higher. However, in 2001, IAS disclosure index surpasses that of U.S. GAAP. Also, the minimum levels shown under U.S. GAAP are also at relatively low level of 48% for 2001 and 36% for 2000 (32% in 1999) (Table 2). The second attribute characterizes companies as providing a full set of financial statements or only reconciliation. It is plausible that the former, whether following IAS or U.S. GAAP, comply more with the related disclosure standards. Table 3 shows that for 1999 and 2000 the disclosure level of companies with full sets of financial statements is higher than that of companies providing only reconciliation. However, the number of firms providing reconciliation decreased from 11 in 1999 to only 1 in 2001. Moreover, the use of condensed formats versus the full report may be interpreted as an indicator of a lower disclosure level. It seems plausible that presenting full format provides more disclosure. Eighteen companies opted for a condensed format in 1999, which was reduced to 10 enterprises in 2000 and to 3 in 2001 when the standardization project of the Deutsche Bo¨rse requires a certain format for financial statements (Table 4). In addition, companies that provide timely reports may present a relatively high disclosure level in order to lower cost of capital. According to the Neuer Markt Rules and Regulation, listed companies are required to electronically transfer the quarterly report to Deutsche Bo¨rse without delay after preparation but not more than 2 months after the end of the reporting period. Fig. 7 illustrates that most of the companies fulfill this requirement. In both 2000 and
Table 4 Influence of full or condensed formats 1999 2000 2001
Condensed Full Condensed Full Condensed Full
n
Mean (%)
Median (%)
Minimum (%)
Maximum (%)
S.D.
18 29 10 37 3 44
48.00 49.31 53.07 56.97 57.65 63.81
48.52 47.78 51.25 55.56 58.15 62.22
24 29 36 32 56 48
71 69 76 86 59 83
0.10565 0.10495 0.11248 0.10360 0.01901 0.08549
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Fig. 7. Influence of days delay for 1999, 2000, and 2001.
2001, companies provided quarterly financial data, on average, 13 days earlier than required (median = 15 days) compared with 11 days in 1999 (see Table 5). In 2001, only one company transferred its report with a delay of 10 days (three in 2000 and four in 1999). The longest delay was 55 days in 1999. The results, however, do not reveal connection between timeliness and disclosure level. We also examine whether larger companies are more likely to acquire professional accounting staff and enhance disclosure. This should in turn enhance the quality of quarterly reports. Fig. 8 shows the correlation between the disclosure level ALL for the years 2001,
Table 5 Timeliness of reports 1999 Mean Median S.D. Minimum Maximum
10.13 11.00 15.06 39 55
2000 13.26 13.00 10.80 50 5
2001 12.72 15.00 12.03 51 10
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Fig. 8. Correlation between disclosure levels ALL 1999, 2000, and 2001 and market capitalization 1999, 2000, and 2001.
Fig. 9. Correlation between index ALL and the time period since listing.
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2001, and 1999 and market capitalization for 2001 (2000 and 1999).16 It is evident that a large number of Neuer Markt companies appear to have neither a particularly high market capitalization nor a high disclosure level. Pearson’s correlation coefficient is not significantly different from zero (.261 for 1999 and .085 in 2000). The situation has changed slightly in 2001: the weak positive correlation of .180 is consistent with previous research (Glaum & Street, 2002). It is also noted that Street and Bryant (2000) and Street and Gray (2001) find no significant association between firm size and level of compliance with IAS or U.S. GAAP required disclosure. Another area for analysis is the possible correlation between disclosure ALL indexes for the years 2001, 2000, and 1999 and the time period since admission to the exchange. We assume that the longer a company is listed on the Neuer Markt, the more reporting it would have and the higher degree of quality in their quarterly reports. Fig. 9 shows a positive trend (Pearson’s correlation coefficients of .154 for 2001, .043 for 2000, and .109 for 1999), suggesting a weak positive correlation between the ALL index and the time period since admission.
5. Conclusion The results demonstrate that the level of disclosure has increased over time. The additional enforcement mechanism has improved quality; the quarterly reports standardization project of Deutsche Boerse was thus successful. However, our analysis shows that important information was not reported. For example, 75% of the companies present all required financial statements in their 9-month report for the year 2000. In 1999, 42% of the enterprises publish the full financial statements. This is in contrast with the Glaum and Street (2002) study in which the majority of sample companies present between 95% and 42% of the required items. Basic information was timely reported in all cases for the 3 years studied. Although the sample companies provided profit information on a regular basis, we did not examine whether a higher disclosure level would have affected market participants differently. While analyzing the results, we should be aware that according to the stock exchange admission regulation in Germany (par. 53–62), companies must have half-year summaries only. Most DAX companies, the German blue chip index, publish quarterly reports, but many listed companies do not. Hence, the Neuer Markt disclosure requirements may be seen as an important landmark in the information environment of listed companies.17 From 1999 to 2001, there has been a significant improvement in the fulfillment of specific rules of IAS 34, although the disclosure level according to U.S. GAAP does not show such an improvement. Despite this difference, the choice between IAS and U.S. GAAP appears to be of less importance for the overall disclosure level. The results also show that neither market 16
The market capitalization was fixed by the end of September 1999, 2000, and 2001 (beginning of October 1999, 2000, and 2001) because the identification of the research date started with the beginning of October 1999. 17 For example, the German index family (DAX, MDAX, and SMAX) requests quarterly reports inspired from the NM Rules and Regulations.
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capitalization nor time period since admission to the Neuer Markt correlate with the disclosure level. One major finding is the increased level of disclosure in quarterly reports. The reasons for this development are the continuous supervision of quarterly reports since the summer of 2000 and the introduction of standardized formats. Nevertheless, the lack of effective supervision for the German capital market continues to be a concern; there is no institution or mechanism that enforces compliance with accounting standards and pursues violations (d’Arcy, 2001). A recent debate has stressed the need for review of quarterly reports through a public or private governmental enforcement body. For example, the German Governmental Commission Corporate Governance (2001) and the European Union (2001) favor the requirement of a limited review of quarterly reports. However, the response of the German Government or the European Union will take time. While the Deutsche Boerse still considers additional steps, whether governmental enforcement should also be established still needs to be discussed.
Acknowledgements The authors gratefully acknowledge helpful comments by Christof Brass, Martin Friedhoff, Christine Roßbach, Richard Willis, and Erin Lynn Berwick. We also acknowledge helpful comments by the participants of the CIERA Symposium March 2002, Illinois.
References Barrett, M. E. (1975). Annual report disclosure: Are American reports superior? Journal of International Business Studies, 6, 15 – 24. Barrett, M. E. (1976). Financial reporting practices: Disclosure and comprehensiveness in an international setting. Journal of Accounting Research, 14, 10 – 26. Barrett, M. E. (1977). The extent of disclosure in annual reports of large companies in seven countries. International Journal of Accounting, 12, 1 – 25. Belkaoui, A. R. (1983). Economic, political, and civil indicators and reporting and disclosure adequacy: Empirical investigation. Journal of Accounting and Public Policy, 2, 107 – 219. Belkaoui, A. R., & Maksy, A. (1985). Welfare of the common man and accounting disclosure adequacy: An empirical investigation. International Journal of Accounting Education and Research, 20, 81 – 94. Benoit, B. (2001, February 5). Will the market always be Nasdaq’s slave? Financial Times, 23. Botosan, C. A., & Plumlee, M. A. (2000, April). Disclosure level and expected cost of equity capital: An examination of analysts’ rankings of corporate disclosure and alternative methods of estimating expected cost of equity capital. Social Science Research Network Electronic Paper Collection (http://papers.ssrn.com/ paper.taf?abstract_id = 224385). Choi, F. D. S. (1973a). Financial disclosure and entry to the European capital market. Journal of Accounting Research, 11, 159 – 175. Choi, F. D. S. (1973b). Financial disclosure in relation to the European capital market. International Journal of Accounting Education and Research, 9, 53 – 66. Choi, F. D. S. (1974). European disclosure: The competitive disclosure hypothesis. Journal of International Business Studies, 5, 15 – 23.
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Commission Corporate Governance (2001, July). Abschlussbericht der Regierungskommission Corporate Governance (http://www.ovs.de/corporate_governance.htm). Core, J. E. (2001, April). A review of the empirical disclosure literature: Discussion. Working Paper. University of Pennsylvania: Wharton School. d’Arcy, A. (2001). Hat sich die internationale Rechnungslegung fu¨r den Neuen Markt bewa¨hrt? In A. Coenenberg, & K. Pohle (Eds.), Internationale Rechnungslegung ( pp. 165 – 177). Stuttgart: Scha¨ffer Poeschel. d’Arcy, A., & Leuz, C. (2000). Rechnungslegung am Neuen Markt—eine Bestandsaufnahme. Die Betriebswirtschaft, 53/8, 385 – 391. Delaney, P. R., Epstein, B. J., Adler, J. R., & Foran, M. F. (2000). Interpretation and application of Generally Accepted Accounting Principles. Wiley-GAAP. New York: Wiley. Deutsche Bo¨rse (1999, November). Secondary markets statistics. Frankfurt. Deutsche Bo¨rse (2001a, September). Neuer Markt, the segment for young growth companies. Frankfurt. Deutsche Bo¨rse (2001b, August). Market circular structured quarterly reports. Frankfurt. Epstein, B. J., & Mirza, A. A. (1999). Interpretation and application of IAS. Wiley-IAS. New York: Wiley. European Union (2001). Towards an EU regime, on transparency obligations of issuers whose securities are admitted to trading on a regulated market. Consultation Document of the Services of the Internal Market Directorate General. July 11, 2001. Financial Times. Bo¨rse upbeat on future of Neuer Markt (2001, August 3), 26. Glaum, M., & Street, D. (2002, April). Rechnungslegung der Unternehmen am Neuen Markt, die Einhaltung der Ausweispflichten nach IAS und US GAAP. Frankfurt: DAI (www.dai.de). Healy, P., & Palepu, K. (2001). Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of Accounting and Economics, 31, 405 – 440. Kieso, D. E., & Weygandt, J. J. (2001). Intermediate accounting (10th ed.). New York: Wiley. KPMG (1999). Rechnungslegung nach US-amerikanischen Grundsa¨tzen: Grundlagen der US-GAAP und SECVorschriften (2nd ed.). Du¨sseldorf: IDW-Verlag. Leuz, C. (2003). IAS versus US GAAP: Information asymmetry-based evidence from Germany’s New Market. Journal of Accounting Research, 41(3), 445 – 472. Leuz, C., & Verrecchia, R. (2000). The economic consequences of increased disclosure. Journal of Accounting Research (38 Suppl.), 91 – 124. Maier, A., & Herr, J. (2000, June 6). Undurchsichtige Quartalsberichte und andere Zumutungen. FAZ, 30. Price Waterhouse (1979). International survey of accounting principles and reporting practices. London: Price Waterhouse. Price Waterhouse Coopers (PWC) (1999). International Accounting Standards: Applying IAS 34 (interim financial reporting) in practice. London: Price Waterhouse Coopers. Sengupta, P. (1998, October). Corporate disclosure quality and the cost of debt. Accounting Review, 459 – 474. Street, D. L., & Bryant, S. M. (2000). Disclosure level and compliance with IASs: A comparison of companies with and without U.S. listings and filings. International Journal of Accounting, 35(3), 305 – 329. Street, D. L., & Gray, S. J. (2001). Observance of International Accounting Standards: Factors explaining noncompliance by companies referring to the use of IAS (ACCA Research Monograph). Verrecchia, R. (1983). Discretionary disclosure. Journal of Accounting and Economics, 5, 179 – 194. Wall Street Journal Europe. Neuer Markt seeks signs of recovery, New IPO, delisting may restore some of battered exchange’s Luste (2000, March 3).
The quality of Neuer Markt quarterly reports—an empirical investigation$ Anne d’Arcy a,*, Sonja Grabensbergerb a
European Accounting and Disclosure Regulation, Corporate Center Controlling, Deutsche Bank AG, D-60325, Frankfurt am Main, Germany b Group Account, Siemens VDO Automotive AG, D-65824 Schwalbach, Germany
Abstract When compared with its prior performance, the year 2001 is not one of the best years for the Neuer Markt. The Neuer Markt’s reputation has been marred by the practice of several companies on the exchange that have published misleading information in the form of incomplete annual and quarterly data. In this study, we examine the quality of Neuer Markt quarterly reports by concentrating on the disclosure level of 47 Neuer Markt companies’ reports for the third quarter of 1999, 2000, and 2001. To enable making comparisons, we have established four disclosure indexes that measure each report’s compliance with the Neuer Markt Rules and Regulations (NM Rules and Regulations) as well as with International Accounting Standards (IAS) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) interim reporting standards. We then attempt to find typical attributes of Neuer Markt enterprises that provide high or low level of disclosure accounting information in their quarterly reports. The results demonstrate that the level of disclosure has increased over time, partly in response to additional enforcement. In this regard, the quarterly reports standardization project of Deutsche Boerse is an important landmark in satisfying investors’ information needs. D 2003 University of Illinois. All rights reserved. Keywords: Deutsche Boerse; Neuer Markt Rules and Regulations; International Accounting Standards; U.S. Generally Accepted Accounting Principles
$
This paper was presented at the International Accounting Summer Conference CIERA Symposium held in Champaign, IL in March 2002. * Corresponding author. E-mail addresses: [email protected] (A. d’Arcy), [email protected] (S. Grabensberger). 0020-7063/03/$30.00 D 2003 University of Illinois. All rights reserved. doi:10.1016/S0020-7063(03)00040-2
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1. Introduction Despite the recent market turndown, Germany’s Neuer Markt, launched in March 1997, was considered to be the most successful stock market for growth companies in Europe in terms of both market capitalization and number of listings (Deutsche Bo¨rse, 2001a). This success can primarily be accounted for by its substantially stricter disclosure and listing requirements compared with other German market segments.1 However, even if the Neuer Markt already boasts some of the tightest regulations in Europe, the general sell-off in technology and Internet stocks, a string of profit warnings, insider-dealing investigations, and insolvencies have shaken investors’ confidence and prices have fallen by more than 90% from its peak reached in March 2000 to its all-time low in 2002 (Wall Street Journal Europe, 2000). This sharp setback in stock prices was a shock not only to many inexperienced retail investors who have for the first time realized a massive loss exposure (Benoit, 2001) but also to institutional investors who seem to be surprised by the free fall of prices. In troubled financial markets, people are eager to seek out plausible explanations, and in some cases, people even find scapegoats. One viable starting point for this quest is questioning what type of information was available for investors and whether or not a better quantity or quality of information could have enhanced investors’ decisions. Quarterly reports are important sources of information, and companies listed on Neuer Markt are required to publish such reports and to prepare their accounts in accordance with either the International Accounting Standards (IAS) or the U.S. Generally Accepted Accounting Principles (U.S. GAAP) [7.1 Neuer Markt Rules and Regulations (NM Rules and Regulations)]. However, quarterly reports of several Neuer Markt companies were criticized as failing to meet investors’ information needs (Maier & Herr, 2000). Important information was either missing or of poor quality. One major criticism is that, even if the rules are heavily influenced by regulation of Nasdaq and the U.S. Securities Exchange Commission (SEC), they lack a comparable enforcement mechanism. In fact, the Neuer Markt listing requirements are set in a rulebook that clearly spells out requirements for the issuer.2 Deutsche Boerse acts as both the standard setter and the enforcement institution at the same time, and there is no government-based supervisor responsible for assuring the quality of quarterly reports. Moreover, Glaum and Street (2002) show that there was considerable noncompliance with IAS and U.S. GAAP disclosure rules in the year 2000 financial statements of 100 Neuer Markt companies. 1
See Financial Times (2001). The NM Rules and Regulations can be downloaded at http://www.deutscheboerse.com/nm. For the analysis, we take the NM Rules and Regulations as of May 21, 2001. 2 The shares are admitted under public law to the Second Segment (Geregelter Markt) with relatively low publication requirements like half-year summaries. Additionally, for the admission under private law to the trading segment ‘‘Neuer Markt,’’ the rules and regulations must be accepted by the issuer. The Executive Board of the Deutsche Boerse can reject the application if the admission criteria of registration conditions are not fulfilled. Moreover, it can terminate the admissions to the Neuer Markt if the issuer does not adhere to the requirements connected with the admission. See Deutsche Boerse Information Folder, Section 2.1, version January 1, 2001. In connection with the new delisting rule, the Frankfurt court stated that the NM Rules and Regulations could be interpreted as general trade conditions, but they showed some particularities. See LG Frankfurt, decision from August 15, 2001—3-13 O 110/01 (nrkr).
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In this study, we concentrate on the disclosure level of quarterly reports of 47 Neuer Markt companies for the third quarter of 1999, 2000, and 2001. We begin by briefly describing in Section 2 the interim reporting standards of the Neuer Markt, IAS, and U.S. GAAP. Section 3 discusses certain approaches that measure the quality of interim reports by disclosure levels. We then compare disclosure indexes that measure the report’s compliance with the NM Rules and Regulations as well as with IAS and U.S. GAAP interim reporting standards. Next, we try to discover typical attributes of Neuer Markt companies that provide high or low level accounting information in their quarterly reports by investigating the correlations between the disclosure level and certain criteria like market capitalization and the time of existence in the Neuer Markt. Section 4 demonstrates that the level of disclosure has increased over time. An additional enforcement mechanism added in 2000 has especially improved reporting quality. In this regard, the quarterly reports standardization project of Deutsche Bo¨rse (2001b) is an important landmark in satisfying investors’ information needs. Section 5 concludes the paper.
2. Interim reporting standards 2.1. NM Rules and Regulations Four years after its launch in March 1997, more than 340 companies were listed on Neuer Markt, 56 of which were headquartered outside Germany.3 The NM Rules and Regulations require the publication of quarterly reports that follow either IAS or U.S. GAAP (d’Arcy & Leuz, 2000). In both cases, Neuer Markt-listed companies are required to publish quarterly reports in both German and English. These reports must contain financial statements and a notes section, the most important components of which are income statement, cash flow statement, and net income or loss per share. For each figure, the previous year’s comparative figure for the corresponding period shall be given (7.1.2 NM Rules and Regulations). The following notes are to be made in the explanatory section, each with comparable figures from the previous year (7.1.3 NM Rules and Regulations): 1. 2. 3. 4. 5. 6.
breakdown of revenues, remarks to the order situation (order backlog), presentation of the development of costs and prices, R&D activities, specification for the investment activities, presentation of personnel changes in the company’s Board of Management Directors or supervisory bodies, 7. explanations of shares held by the company and subscription rights of officers and employees, 3
See Deutsche Bo¨rse (2001a). See also Leuz (2003, pp. 450 – 452) for a brief description of the Neuer Markt.
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8. explanation regarding distribution of interim dividends,4 and 9. number of employees. If a Neuer Markt-listed company published its preceding annual report on a consolidated basis, then the quarterly report consisting of the financial statements and the explanatory notes are to be prepared on a consolidated basis too (7.1.4 NM Rules and Regulations). In Article 7.1.7 of the NM Rules and Regulations, it is stated that the quarterly report has to be transmitted immediately following its completion and within at least 2 months of the end of the relevant reporting period. In this case, we analyze the Neuer Markt-listed companies that have electronically submitted the quarterly report within the prescribed period.5 Furthermore, at the request of the company, Deutsche Boerse may, under some circumstances, permit a reconciliation of national accounting principles to IAS or U.S. GAAP (7.3.2 NM Rules and Regulations). Deutsche Boerse comments that this reconciliation statement must in its material aspects have the format of the U.S. GAAP reconciliation statement. From the viewpoint of Deutsche Boerse, this reconciliation statement can be regarded to be the minimum reporting to be presented. 2.2. Interim financial reporting according to IAS 34 IAS 34 sets detailed rules for interim reporting in order to make sure that investors are informed of the latest financial news of a company. Quarterly reports should preferably focus on new activities, events, and circumstances that have occurred since the publication of the latest annual financial statements. Thus, IAS 34 has softened the presentation of quarterly reports compared with annual financial statements (Epstein & Mirza, 1999, p. 651). A quarterly report in accordance with IAS 34 must contain financial statements and explanatory notes. The standard mandates that the following financial statements components be presented either in full (IAS 34.5) or in a condensed format,6 each with comparable figures for the previous year (IAS 34.20): balance sheet, income statement, EPS (basic/diluted) (IAS 34.11), cash flow statement, and statement of changes in stockholder’s equity.7
4
In some countries, it is allowed to distribute interim dividends, whereas this is forbidden to German public companies. See Section 59 AktG. For this reason, only non-German companies were analyzed whether this specification was given or not. 5 The publication period postulated in the NM Rules and Regulations does overrule neither the IAS recommended 60-day period [IAS 34.1 (b)] nor the U.S. GAAP required 45-day period (Form 10-Q, General Instructions A.1.) because it is to be regarded as special rule of Neuer Markt-listed companies. 6 If a company presents its quarterly report in a ‘‘condensed format,’’ then IAS 34.10 requires that, at a minimum, those ‘‘condensed financial statements’’ should include each of the headings and the subtotals that were included in the company’s most recent annual financial statement. 7 According to IAS 34.8c, the companies can choose between the presentation of a statement of changes in stockholders’ equity and a statement of comprehensive income. None of the Neuer Markt-listed companies chose the possibility of showing a comprehensive income statement. Thus, we only examine these companies whether they present the statement of changes in stockholders’ equity or not.
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The explanatory notes that accompany financial statements state the minimum disclosures to be made, as outlined below (IAS 34.16): 1. a statement that the same accounting policies and methods are applied in the quarterly report compared with the most recent annual report, 2. comments about seasonality or cyclicality of interim operations, 3. nature and magnitude of significant items affecting interim results that are unusual because of nature, size, or incidence, 4. nature and quantum of changes in estimates, if affecting the actual report, 5. issuance, repurchases, and repayments of debt and equity securities, 6. dividends paid, 7. revenue and operating results for business segments or geographical segments, which represent the company’s primary mode of segment reporting: If a company is obliged to prepare a ‘‘complete set of financial statements,’’ then it shall follow IAS 14 (Price Waterhouse Coopers (PWC), 1999, p. 5). 8. significant events occurring subsequent to the end of the reporting period, 9. changes in the composition of companies to be consolidated, and 10. changes in contingent liabilities or assets. IAS 34.14 requires consolidated financial statements if the preceding annual financial statements were presented on a consolidated basis. 2.3. Interim financial reporting according to U.S. GAAP The basic objective of the U.S. GAAP interim reporting is to provide investors and others with timely information as to the progress of the enterprise. The timeliness of presentation may be partially offset by a modification in detail in the information provided (APB 28.9 and 30) (Epstein & Mirza, 1999, p. 757). As a result, using APB 28 as a guideline allows a company to present quarterly reports either in a ‘‘summarized form’’ or as a ‘‘complete set of financial statements.’’ APB 28 represents the general guideline among other SFAS, FASB Interpretations, and for certain practical aspects the regulation S-X (Delaney, Epstein, Adler, & Foran, 2000, p. 757). If a Neuer Markt company has decided to prepare its quarterly report according to U.S. GAAP, it would have to show the following financial statements components, each with comparable preceding year’s figures (APB 28.2 and 33): balance sheet, income statement,8 cash flow statement, segment report (for condensed form overview only) (APB 28.30), and statement of changes in stockholders’ equity.9 8 APB 28 requires for the income statement the presentation of significant items only. To close this interpretative gap, the NM Rules and Regulations requires explicitly an entire income statement. This was also clarified by the Deutsche Bo¨rse by the market circular on Structured Quarterly Reports. 9 For 1999 and 2000, none of the Neuer Markt-listed companies chose the possibility of showing a comprehensive income statement. Thus, we only examine these companies whether they present the statement of changes in stockholders’ equity or not.
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The type and scope of the complete set is determined by the most recent annual report.10 For both formats, the following disclosure should be reported as a minimum (APB 28.30) (Kieso & Weygandt, 2001, p. 1397): 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.
sales or gross revenues, provisions for income taxes, extraordinary items, cumulative effect of a change in accounting principles or practices, net income, EPS (basic), EPS (diluted), seasonal revenue, costs, or expenses, significant changes in estimates or provisions for income taxes, disposal of a segment of a business and extraordinary, unusual, or infrequently occurring items, 11. contingent items, 12. changes in accounting principles or estimates, and 13. significant changes in financial positions. Quarterly reports according to U.S. GAAP shall be based on the same accounting policies and practices used by the company in the preparation of its most recent annual report. Three companies of our sample are dual listed on the Neuer Markt as well as on Nasdaq. They use the Form 10-Q instead of a quarterly report, which was accepted by Deutsche Boerse.
3. Methodology and research data 3.1. Methodology: developing disclosure indexes Corporate finance theory predicts that companies endogenously optimize disclosure policy in order to maximize firm value. This choice involves trading off the reduction in the information asymmetry component of the cost of capital that results from increased disclosure quality (see Leuz & Verrecchia, 2000; Verrecchia, 1983; for an empirical literature overview, see Core, 2001; Healy & Palepu, 2001). For firms with low growth opportunities, a minimum disclosure may be of sufficiently high quality because those firms have no need for external finance and therefore are not influenced by the cost of new equity capital.11 For firms with high growth opportunities—like Neuer Markt companies—information asymmetry is high and some reduction through voluntary disclosure would seem optimal (Core, 2001, pp. 2–3). 10
This is the interpretation of KPMG regarding Neuer Markt-listed companies preparing the quarterly reports under U.S. GAAP. See also KPMG (1999, p. 181). 11 However, there is some empirical evidence that disclosure quality also influences the cost of debt (Sengupta, 1998).
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Accordingly, a number of empirical studies suggest a link between cost of equity capital and disclosure (Botosan & Plumlee, 2000, p. 3). To accept this connection, we first have to define the disclosure level as an indicator for reporting quality. Recent empirical disclosure literature suggests that mandatory disclosure is enforced and therefore does not have to be included in a disclosure quality index. This assumption does not hold for the Neuer Markt because one major criticism concentrates on the noncompliance of some issuers with existing rules. Furthermore, the companies have to report in accordance with the NM Rules and Regulations as well as those of either IAS or U.S. GAAP. Accordingly, we have to consider different systems. We find a related research question in the comparison of national accounting systems by disclosure levels. In the 1970s, Barrett (1975, 1976, 1977) developed an ‘‘index of disclosure,’’ which measured the complexity and adequacy of accounting information for certain national accounting systems by investigating the disclosure of several annual reports. The presence of 17 ‘‘items of information’’ in each report determines the index. As a result, companies, especially American and British ones, show high values, whereas the continental European firms indicate relatively low degrees with France at the bottom.12 Also, in the 1970s, Choi (1973a, 1973b, 1974) published three studies about the relation of external environmental factors to the capital market influence on accounting and the quality of financial reporting practices. Similar to Barrett’s method, Choi measures the degree by a ‘‘level of disclosure’’ that is based on 36 ‘‘items of information.’’ Belkaoui (1983) uses a partly related concept that evaluates national accounting systems by a ‘‘reporting and disclosure adequacy index’’ based on the Price Waterhouse (1979) database on accounting practices. The index is calculated by summing the ordinal categories of all items for each country, which includes disclosure as well as measurement practices. The enclosed test of significance does not prove a strong relation between this index and several environmental factors. Furthermore, Belkaoui and Maksy (1985) test the relation between the ‘‘reporting and disclosure adequacy index’’ and the concept of the ‘‘welfare of the common man.’’ As in the earlier study, they did not verify the existence of a significant dependence. Nowadays, several databases of annual reports provide information on whether or not several disclosure items are included.13 The most recent study from Glaum and Street (2002) on the compliance with the disclosure requirements of Neuer Markt companies derived the dependent variable from a checklist that coded disclosure items as disclosed, not disclosed, or not applicable. Glaum and Street calculated a disclosure compliance index for each company by dividing the total number of required disclosures by the number of applicable disclosures. The above-noted studies define the disclosure level by adding up the number of disclosure items. Similarly, we establish disclosure levels by defining items of information that should 12
In his analysis from 1975, Barrett makes use of the reports of the 15 biggest enterprises for each country only. In the later studies form 1976 and 1977, the database considers 103 reports from the financial years 1963 – 1972. 13 See, for example, the AIMR reports (http://www.aimr.org).
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be included in the interim report following the related standards as described in Section 2. For each level, we compute 1999, 2000, and 2001 numbers to investigate developments. a. The first index, FINANCIALS, is noted by one if all parts of an interim report are present, namely the income statement, the balance sheet, the cash flow statement, and the earnings per share figure, each with comparable preceding year’s figures. This measure is independent from type of accounting standards employed.14 b. The second index, NM, indicates compliance with explicit disclosure regulations of the Neuer Markt as described in Section 2.1. c. The third index, IAS, scales the compliance with IAS 34 disclosure rules for companies that follow IAS. d. The fourth index, US, shows the conformity with U.S. GAAP interim reporting standards as described in Section 2.3. e. Finally, we establish the index ALL, which describes the overall disclosure level for all companies under review on a percent basis. The indexes FINANCIALS, NM, and either IAS or US are accumulated while eliminating duplicate information, e.g., earnings per share figures that are part of FINANCIALS and US. 3.2. Limitations We are aware of the limitations of this research approach. The indexes are defined as simple sums. Because all items of information are equally weighted, important items may be swamped by trivial ones. Consistent with other approaches, we measure how well the reports conform to the related standards. This method may not provide a strong indicator of the quality of accounting numbers that are not public information. Although we view disclosure quality in a narrow sense, the results offer an opportunity to gain new insights into the level of information that companies publish on a quarterly basis. Thus, these results cannot be interpreted as a complete measure of compliance with interim reporting standards. Although Glaum and Street (2002) differentiate between ‘‘not applicable’’ and ‘‘not disclosed’’ data and calculate an overall compliance index, they also use publicly available information and are therefore not able to differentiate between missed disclosure and not satisfying certain criteria. Thus, a disclosure index can be interpreted only in a relative sense, and we have established a 3-year comparison to analyze possible developments. 3.3. Research data We use only a sample of the 174 companies listed on the Neuer Markt at the end of October 1999 that were required to submit quarterly reports.15 Only companies that published 14 We do not include the statement of changes in stockholders’ equity in this figure because it is not required in all cases. However, FINANCIALS do not provide us the full information on the compliance regarding the components of an interim report for companies that tend to follow IAS. 15 All Neuer Markt-listed companies that receive listing authorization during the accounting period are obliged to provide a quarterly report. This is implicitly stated in 7 NM Rules and Regulations.
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Table 1 Accounting standards used and usage of reconciliation 1999
2000
2001
U.S. GAAP IAS Total U.S. GAAP IAS Total U.S. GAAP IAS Total
Full
Reconciliation
Total
23 13 36 26 19 45 25 21 46
5 6 11 1 1 2 1 0 1
28 19 47 27 20 47 26 21 47
the six monthly and the third quarter reports for 1999 were selected for the initial sample. We deleted four firms that we could not identify the accounting regime used, and based on internal Deutsche Bo¨rse advice, market capitalization was either less than 80 million or greater than 3 billion euros (Deutsche Bo¨rse, 1999). We further reduce this sample for 2000 by two companies due to insolvency and merger. In 2001, five more companies of the original sample were delisted. We use the sample of 47 Neuer Markt companies to compare quarterly reports of the third quarter of 1999 with those of the third quarter of 2000 and 2001. The accounting standards adopted and the extent of using reconciliation (instead of a full set of financial statements) for the sample of 47 companies is presented in Table 1.
4. Results 4.1. Disclosure levels Fig. 1 shows the frequencies for the FINANCIALS index for 1999, 2000, and 2001. In 1999, only 20 companies (43%) show all elements of an interim report with an average of 6.62 out of a maximum of 8 elements shown. Nearly three-quarters of the firms fulfill this
Fig. 1. Frequencies of FINANCIALS.
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Fig. 2. Frequencies of NM.
requirement in 2000, with an average of 7.32. The S.D. decreases from 1.38 to 1.12. In 2001, all companies show the basic elements of an interim report based on the formats required by Deutsche Bo¨rse. It appears that standardization of quarterly reports has succeeded in enforcing certain levels of disclosure. In 1999 and 2000, the comparable figures in the preceding year are missing in some cases. One company does not provide a cash flow statement in 2000 (three in 1999). In 6 cases, the EPS figure is missing in 2000 compared with 10 in 1999. Six companies do not present a balance sheet in 2000 (11 in 1999). This is likely to be due to the fact that the 1999 version of the NM Rules and Regulations did not explicitly require a balance sheet although it is required by both IAS and U.S. GAAP. Fig. 2 shows the frequencies that indicate compliance with the NM Rules and Regulations. Some rules are only applicable under certain conditions, e.g., disclosure about changes in the boards. It is therefore not surprising that only one company reaches the maximum sum of nine (in 2001). Relevant information is often missing: eight companies do not show a breakdown of their revenues in 1999 (only one in 2000); three of the companies that publish their quarterly reports on Form 10-Q ignored the Neuer Markt disclosure requirements. However, the index has increased by about 21% from 1999 and 2000 and by 19% from 2000 to 2001. On average, sample companies show 3.81 items of information (median = 4) in 1999, 4.62 (median = 4) in 2000, and 5.51 (median = 6) in 2001. This change was accompanied by a
Fig. 3. Frequencies of IAS.
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Fig. 4. Frequencies of US.
more moderate increase in the S.D. from 1.35 in 1999 to 1.78 in 2001. There is nevertheless important information that remain undisclosed, e.g., major investments or R&D activities. Forty-six companies provided disclosure on their own shares in 2001 while there were only two companies in 2000, whereas no company disclosed own share information in 1999. The same is true with the IAS index (Fig. 3). Two companies (of 19) in 1999 and one (of 20) in 2000 do not provide even one item of information following IAS 34 requirements. Segment information was not disclosed for more than the 60% of the companies under review, although this effect may be traced back to IAS 14, which did not require segment information in all cases. However, the 18 companies that had provided segment information in 2001 represents a significant increase when compared with 3 in 1999 and 8 in 2000. The mean index increases from 1.68 in 1999 to 2.45 (with an increasing S.D. from 0.95 to 1.32). In 2001, the mean reaches 3.19, an increase of 30%, while the median increases from 2 to 3. The S.D. remains almost unchanged at 1.36. For the US index (Fig. 4), not all of the 13 items are disclosed by all companies even if they report according to the detailed SEC regulations Form 10-Q as shown by the high S.D. of 2.06 in 2000 and 1.95 in 1999, which declines to 1.53 in 2001. The increase of the index mean from 4.39 in 1999 (4.26 in 2000) to 5.12 in 2001 is not as high as the increase for other
Fig. 5. Mean development.
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Fig. 6. ALL index: histogram of frequencies.
indexes. Essential information, such as basic earnings per share figures, are not given by eight firms for 2000 (six for 1999), whereas all companies provide earnings per share information in 2001; despite the fact that almost all companies may have a dilutive effect on the earnings per share figure from their contribution plans, dilutive earnings per share numbers are presented by 19 companies for 2001, 8 for 2000, and 9 for 1999. In summary, except for the basic parts in 2001, the disclosure indexes are not as high as would be expected. However, the relative disclosure levels have been increasing (see Fig. 5) over the 3 years studied. The IAS disclosure level grows at over 30% per year, whereas the US disclosure level is more constant. These conclusions are confirmed by analyzing the ALL index for 1999, 2000, and 2001 (see Fig. 6). The overall disclosure level for all companies increased up from 48.81% to 56.13% and 63.42%, an increase of 15% in 1 year, while the S.D. remained almost constant. The second year shows an increase of 13% with a lower S.D. of 0.83. 4.2. Correlations We looked for correlated patterns to characterize how a company with a high or low disclosure level can be characterized. The first important attribute may be the accounting principles used. U.S. GAAP is enforced for three companies in this study because they are
Table 2 ALL IAS and ALL US
n Mean (%) Median (%) S.D. Minimum (%) Maximum (%)
ALL IAS 1999
ALL US 1999
ALL IAS 2000
ALL US 2000
ALL IAS 2001
ALL US 2001
19 46.30 47.22 0.0996 24.07 62.96
28 50.51 48.98 0.1057 32.04 71.48
20 53.26 52.78 0.1017 31.94 70.37
27 58.27 58.06 0.1051 35.74 85.93
21 63.67 66.67 0.0912 48.15 77.78
26 63.22 62.22 0.0798 47.78 82.96
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Table 3 Influence of full format versus reconciliation 1999 2000 2001
Full accounts Reconciliation Full accounts Reconciliation Full accounts Reconciliation
n
Mean (%)
Median (%)
Minimum (%)
Maximum (%)
S.D.
36 11 45 2 46 1
49.94 45.10 56.53 47.31 63.53 58.15
50.56 42.78 55.56 47.31 62.22 n.a.
24 29 32 44 48 58
71 59 86 51 83 58
0.10644 0.09154 0.10586 0.05369 0.08470 n.a.
listed on a US exchange. By comparing the index ALL in the disclosure level for companies that follow IAS and those that follow U.S. GAAP, we find the disclosure level of these U.S. GAAP companies to be higher. However, in 2001, IAS disclosure index surpasses that of U.S. GAAP. Also, the minimum levels shown under U.S. GAAP are also at relatively low level of 48% for 2001 and 36% for 2000 (32% in 1999) (Table 2). The second attribute characterizes companies as providing a full set of financial statements or only reconciliation. It is plausible that the former, whether following IAS or U.S. GAAP, comply more with the related disclosure standards. Table 3 shows that for 1999 and 2000 the disclosure level of companies with full sets of financial statements is higher than that of companies providing only reconciliation. However, the number of firms providing reconciliation decreased from 11 in 1999 to only 1 in 2001. Moreover, the use of condensed formats versus the full report may be interpreted as an indicator of a lower disclosure level. It seems plausible that presenting full format provides more disclosure. Eighteen companies opted for a condensed format in 1999, which was reduced to 10 enterprises in 2000 and to 3 in 2001 when the standardization project of the Deutsche Bo¨rse requires a certain format for financial statements (Table 4). In addition, companies that provide timely reports may present a relatively high disclosure level in order to lower cost of capital. According to the Neuer Markt Rules and Regulation, listed companies are required to electronically transfer the quarterly report to Deutsche Bo¨rse without delay after preparation but not more than 2 months after the end of the reporting period. Fig. 7 illustrates that most of the companies fulfill this requirement. In both 2000 and
Table 4 Influence of full or condensed formats 1999 2000 2001
Condensed Full Condensed Full Condensed Full
n
Mean (%)
Median (%)
Minimum (%)
Maximum (%)
S.D.
18 29 10 37 3 44
48.00 49.31 53.07 56.97 57.65 63.81
48.52 47.78 51.25 55.56 58.15 62.22
24 29 36 32 56 48
71 69 76 86 59 83
0.10565 0.10495 0.11248 0.10360 0.01901 0.08549
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Fig. 7. Influence of days delay for 1999, 2000, and 2001.
2001, companies provided quarterly financial data, on average, 13 days earlier than required (median = 15 days) compared with 11 days in 1999 (see Table 5). In 2001, only one company transferred its report with a delay of 10 days (three in 2000 and four in 1999). The longest delay was 55 days in 1999. The results, however, do not reveal connection between timeliness and disclosure level. We also examine whether larger companies are more likely to acquire professional accounting staff and enhance disclosure. This should in turn enhance the quality of quarterly reports. Fig. 8 shows the correlation between the disclosure level ALL for the years 2001,
Table 5 Timeliness of reports 1999 Mean Median S.D. Minimum Maximum
10.13 11.00 15.06 39 55
2000 13.26 13.00 10.80 50 5
2001 12.72 15.00 12.03 51 10
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Fig. 8. Correlation between disclosure levels ALL 1999, 2000, and 2001 and market capitalization 1999, 2000, and 2001.
Fig. 9. Correlation between index ALL and the time period since listing.
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2001, and 1999 and market capitalization for 2001 (2000 and 1999).16 It is evident that a large number of Neuer Markt companies appear to have neither a particularly high market capitalization nor a high disclosure level. Pearson’s correlation coefficient is not significantly different from zero (.261 for 1999 and .085 in 2000). The situation has changed slightly in 2001: the weak positive correlation of .180 is consistent with previous research (Glaum & Street, 2002). It is also noted that Street and Bryant (2000) and Street and Gray (2001) find no significant association between firm size and level of compliance with IAS or U.S. GAAP required disclosure. Another area for analysis is the possible correlation between disclosure ALL indexes for the years 2001, 2000, and 1999 and the time period since admission to the exchange. We assume that the longer a company is listed on the Neuer Markt, the more reporting it would have and the higher degree of quality in their quarterly reports. Fig. 9 shows a positive trend (Pearson’s correlation coefficients of .154 for 2001, .043 for 2000, and .109 for 1999), suggesting a weak positive correlation between the ALL index and the time period since admission.
5. Conclusion The results demonstrate that the level of disclosure has increased over time. The additional enforcement mechanism has improved quality; the quarterly reports standardization project of Deutsche Boerse was thus successful. However, our analysis shows that important information was not reported. For example, 75% of the companies present all required financial statements in their 9-month report for the year 2000. In 1999, 42% of the enterprises publish the full financial statements. This is in contrast with the Glaum and Street (2002) study in which the majority of sample companies present between 95% and 42% of the required items. Basic information was timely reported in all cases for the 3 years studied. Although the sample companies provided profit information on a regular basis, we did not examine whether a higher disclosure level would have affected market participants differently. While analyzing the results, we should be aware that according to the stock exchange admission regulation in Germany (par. 53–62), companies must have half-year summaries only. Most DAX companies, the German blue chip index, publish quarterly reports, but many listed companies do not. Hence, the Neuer Markt disclosure requirements may be seen as an important landmark in the information environment of listed companies.17 From 1999 to 2001, there has been a significant improvement in the fulfillment of specific rules of IAS 34, although the disclosure level according to U.S. GAAP does not show such an improvement. Despite this difference, the choice between IAS and U.S. GAAP appears to be of less importance for the overall disclosure level. The results also show that neither market 16
The market capitalization was fixed by the end of September 1999, 2000, and 2001 (beginning of October 1999, 2000, and 2001) because the identification of the research date started with the beginning of October 1999. 17 For example, the German index family (DAX, MDAX, and SMAX) requests quarterly reports inspired from the NM Rules and Regulations.
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capitalization nor time period since admission to the Neuer Markt correlate with the disclosure level. One major finding is the increased level of disclosure in quarterly reports. The reasons for this development are the continuous supervision of quarterly reports since the summer of 2000 and the introduction of standardized formats. Nevertheless, the lack of effective supervision for the German capital market continues to be a concern; there is no institution or mechanism that enforces compliance with accounting standards and pursues violations (d’Arcy, 2001). A recent debate has stressed the need for review of quarterly reports through a public or private governmental enforcement body. For example, the German Governmental Commission Corporate Governance (2001) and the European Union (2001) favor the requirement of a limited review of quarterly reports. However, the response of the German Government or the European Union will take time. While the Deutsche Boerse still considers additional steps, whether governmental enforcement should also be established still needs to be discussed.
Acknowledgements The authors gratefully acknowledge helpful comments by Christof Brass, Martin Friedhoff, Christine Roßbach, Richard Willis, and Erin Lynn Berwick. We also acknowledge helpful comments by the participants of the CIERA Symposium March 2002, Illinois.
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