Capital Market Consequences of Managers’ Voluntary Disclosure Styles

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Wednesday September 21, 2011 at 9:21 am
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Editor’s Note: The following post comes to us from Holly Yang of the Department of Accounting at the University of Pennsylvania.

In the paper, Capital Market Consequences of Managers’ Voluntary Disclosure Styles, which is forthcoming in the Journal of Accounting and Economics, I examine the capital market consequences of managers establishing an individual disclosure style. While both neoclassical economic and agency theories suggest that managers’ individual preferences should not have an effect on corporate outcomes, several recent academic studies find that managers have styles of their own that they carry from one firm to the other. Anecdotal evidence also suggests that manager credibility matters to financial analysts, who penalize CEOs and CFOs that fail to effectively manage expectations. To the extent that these manager-specific “styles” affect investors’ perceptions of the manager’s overall reputation and credibility, investors should take this into consideration when responding to managers’ disclosure decisions.

I examine my research question in the context of management earnings forecasts, a disclosure choice that has become more common among firms after the adoption of the Private Securities Litigation Reform Act in 1995. Using a sample of management earnings forecasts issued between 1996 and 2009, I find that there is significant variation in the forecast accuracy of the CEOs and CFOs in my sample. Managers in the top quartile issue forecasts that are more accurate by 4.6% of price than those in the bottom quartile. Building on research in psychology and management, which argues that individual differences are accentuated under uncertain situations, I also hypothesize and find that investors respond more strongly to forecasts issued by managers with higher prior forecasting accuracy when information uncertainty is high. This suggests that when there is high uncertainty in the information environment, investors are more likely to react to news delivered by managers with higher credibility.

Overall, unlike prior studies which implicitly assume that a firm’s disclosure behavior is attached to the firm or its entire management team, this study provides the first evidence that managers can develop a personal reputation via their disclosure behavior, and is consistent with managers’ concerns about establishing a personal reputation for accurate and transparent reporting.

The full paper is available for download here.

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