Accounting Research Center, Booth School of Business, University of Chicago

Cross-Sectional Determinants of Analyst Ratings of Corporate Disclosures Author(s): Mark Lang and Russell Lundholm Source: Journal of Accounting Research, Vol. 31, No. 2 (Autumn, 1993), pp. 246-271 Published by: Blackwell Publishing on behalf of Accounting Research Center, Booth School of Business, University of Chicago Stable URL: http://www.jstor.org/stable/2491273 . Accessed: 02/05/2011 01:30
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Journal of Accounting Research Vol. 31 No. 2 Autumn 1993 Printed in U.S.A.

Cross-Sectional Determninants of Analyst Ratings of Corporate Disclosures

MARK LANG* AND RUSSELL LUNDHOLMt

1. Introduction
In this paper we examine cross-sectional variation in analysts' published evaluations of firms' disclosure practices and provide evidence that the analysts' ratings are increasing in firm size and in firm performance as measured by earnings and return variables, decreasing in the correlation between earnings and returns, and higher for firms issuing securities in the current or future period. Results based on the volatility of past performance are mixed. While the SEC's mandatory disclosure requirements provide a basic framework and minimum standard for many financial disclosures, considerable latitude remains in determining what information is actually provided. Some firms' annual and quarterly reports go well beyond the required disclosures, while others are extremely stark. Less formal communication channels, such as press releases and direct contact with analysts, allow even more discretion. This wide range of disclosure alternatives is aggregated by analysts in the Reports of the Financial Analysts
*Stanford University; tUniversity of Michigan. We thank A. Alford, B. Beaver, S. Bonner, J. Hughes, B. Johnson, W. Landsman, F. Lindahl, M. McNichols, F. Selto, W. Shaw, S. Teoh, P. Wilson, J. Wahlen, an anonymous referee, the participants at the 1991 University of Iowa Sidney G. Winter Lectures Series, and workshop participants at Stanford University, the University of North Carolina, Duke University, the University of Texas, the University of Colorado, the University of California at Los Angeles, the University of Minnesota, Harvard University, and the American Accounting Association for their helpful comments, and Lynch, Jones & Ryan for providing the analyst forecast data. 246
Copyright (?, Institute of Professional Accounting 1993

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(FAFReports)to provide an overFederationCorporate InformationCommittee all measure of corporate communications with investors. A typical year's report provides a detailed analysis of disclosure practices for about 27 industries, with an average of 17 firms evaluated by an average of 13 analysts in each industry, summarized with ratings in three categories: annual published information, quarterly and other published information, and investor relations. To explain the analysts' ratings of firm disclosure, we consider variables suggested by existing research on voluntary disclosure.' Theoretical research provides several motivations for disclosure -overcoming adverse selection, reducing transaction costs in the market, and reducing expected legal costs by preempting large negative stock price reyield predictions about sponses to earnings announcements-which the relation between disclosure and various firm characteristics, including performance, information asymmetry between investors and managers, incentives for private information acquisition, legal exposure, propensity to access capital markets, and disclosure costs. Much of the empirical research on disclosure focuses on management earnings forecasts and generally finds that the frequency of such forecasts is higher for large firms, firms with less volatile earnings, and firms issuing securities. Evidence on the relation between the frequency of management forecasts and firms' earnings and stock price performance is mixed. While management earnings forecasts reported in the financial press are concrete and measurable, they represent only one of many corporate disclosures. In contrast, the FAF data provide a more comprehensive measure that includes both quantifiable and nonquantifiable aspects of disclosure. In addition, the FAF ratings are based on the perceptions of analysts, arguably the primary users of financial disclosures.2 A disadvantage of the FAF data is that they are based on analysts' perceptions of disclosure rather than direct measures of actual disclosure. Other research which focuses on perceptions of firms' disclosures includes Sutley [1992], who finds that winners of the Financial Post's annual report award have smaller earnings response coefficients and
1 In choosing variables from the voluntary disclosure literature, we assume that analyst The FAF Report suggests this, stating that the ratings measure disclosure informativeness. in communicating with investors" analysts attempt to measure "the firm's effectiveness and the extent to which information is provided "so that investors have the information using all disclosures by the firm, both qualitanecessary to make informed judgments," tive and quantitative. However, because the analyst ratings may be affected by other facin interpreting the empirical results. This issue is tors, care should be exercised discussed in more detail in section 3. 2 In addition, because the management earnings forecast literature focuses on announcements in the financial press, cross-sectional of disclosure are potencomparisons may be tially confounded by editorial bias; certain types of firms or announcements more likely to be covered in the financial press.

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In addition, smaller return-earnings correlations than nonwinners. Imhoff [1992] surveys analysts and provides evidence that their perceptions of "accounting quality" are increasing in the predictability of earnings, firm size, and the stability of the relation between earnings and sales, and decreasing in the likelihood of a bad news annual earnings announcement and the debt-to-equity ratio. Using the survey data from Imhoff [1992] and the overall disclosure scores from the FAF Reports, Imhoff and Thomas [1989] find that firms with high-quality ratings by analysts tend to use more conservative accounting practices and have higher FAF disclosure scores, but that firm profitability is the only variable related to both conservative accounting practices and disclosure scores.3 In the next section we discuss the relation between disclosure choices and firm characteristics. Then we discuss the FAF data in more detail; finally, we present the empirical analysis, interpretations of the results, and conclusions.

2. Literature Review and Motivation

Because a firm's disclosure decisions are influenced by a variety of considerations, we structure our empirical analysis based on a survey of the theoretical and empirical literatures rather than relying on any particular model. We consider six potential variables explanatory grouped for convenience into three categories-performance variables (returns and analyst forecast errors), structural variables (firm size, return variability, and the correlation between annual returns and earnings), and the offer variable (the extent to which the firm is active in issuing securities). The performance variables are time period specific, representing information to which management may have preferential access and which is likely to be the subject of disclosure during the period. The structural variables measure firm characteristics that are widely known and likely to remain relatively stable over time. The offer variable does not fit neatly into either group-securities offerings are time period specific, but firms which offer securities generally do so repeatedly, and security issuance is a choice variable for the firm. 2.1
DISCLOSURE AND FIRM PERFORMANCE

The perception that firms' willingness to disclose information is related to their performance is widespread, but the direction of the relation is not clear. Underlying many of the SEC's deliberations and the discussion in exchange listing guides, for example, is a concern that management will tend to be more forthcoming when the firm is per3 Other studies of disclosure, which have used researcher-created disclosure indexes, mostly predate the development of voluntary disclosure theory and are primarily descriptive. See Ball and Foster [1982] for a summary.

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forming well than when it is performing poorly.4 While legal requirements and listing agreements mitigate an overemphasis on good news, managers may still disclose selectively.5 A positive relation between disclosure and firm performance is also implied by theoretical models of voluntary disclosure in the face of adverse selection. In general, these papers predict that, in the presence of disclosure costs, firms whose performance exceeds a certain threshold will disclose, while those below the threshold will not.6 An alternative motive for disclosure is to reduce transaction costs. In Diamond [1985], firms can precommit to disclosure prior to observing performance, reducing the incentive for private information acquisition.7 King, Pownall, and Waymire [1990] argue that firms may issue management earnings forecasts to reduce the incentives for private information acquisition and hypothesize that the frequency of such forecasts will be positively correlated with factors that increase the potential returns to private information acquisition.8 In these models, disclosure is unrelated to firm performance because firms precommit to a disclosure policy. On the other hand, certain types of negative information (particularly earnings information) may be disclosed voluntarily to reduce the likelihood of legal liability. Skinner [1992] argues that management earnings forecasts may reduce expected legal costs by reducing the likelihood that an imminent mandatory disclosure will result in a large negative stock price response.9 The empirical evidence on the relation between firm performance and disclosure is mixed. Some research on management earnings forecasts (e.g., Patell [1976], Penman [1980], and Lev and Penman [1990]) suggests that firms tend to disclose more frequently when they are
4See Accounting Series Release Nos. 138 and 177 for a discussion of this issue in the context of SEC releases and Walton [1992] for a discussion of exchange disclosure requirements. 5 Pastena and Ronen [1979] discuss this issue and Cohen [1992] provides examples from biotechnology firms' press releases. 6 Related papers include McNichols [1984], Dye [1985; 1986], Jung and IKwon[1988], Verrecchia [1983; 1990], Darrough and Stoughton [1990], Wagenhoefer [1990], and Feltham and Xie [1993]. In a setting where more information allows investors to smooth consumption across periods, Newman and Sansing [1992] show that firms with better news disclose more precise information. In addition, Lang and Lundholm [1992], who empirically examines adverse selection motives for disclosure, demonstrate that the same results extend to an environment with multiple signals. 7However, Alles and Lundholm [1993] show that this result holds for independent private signals but not for correlated signals. 8Related research includes Merton [1987] and Fishman and Hagerty [1989] in which disclosure reduces the cost of becoming informed, thereby increasing the number of investors willing to invest in the firm and lowering the firm's cost of capital. 9 Discussions with securities lawyers suggest that the practice of "walking the Street down" (attempting to lower the market's estimate of earnings gradually through a series of moderately negative announcements) is a common phenomenon.

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experiencing favorable earnings results and that earnings forecasts are, on average, associated with positive returns. However, research focusing on later time periods (e.g., Ajinkya and Gift [1984] and McNichols [1989]) indicates that firms are as likely to issue good news forecasts as bad news forecasts. Further, recent research provides evidence that firms issuing general earnings-related information (Skinner [1992]) and preliminary earnings estimates (Baginski, Hassell, and Waymire [1992]) are more likely to disclose bad news than good news. Papers which incorporate other measures of voluntary disclosure include McNichols [1988], who concludes, based on the negative skewness of returns on earnings announcement dates, that good news is while bad news is disclosed disclosed prior to earnings announcements through announced earnings. Pastena and Ronen [1979] compare hard information (defined as information with "a high probability of imminent disclosure by sources uncontrollable by management or as a result of an audit") with soft information (the complement of hard information) and find that firms tend to disseminate positive information earlier than negative information and that soft information releases tend to be positive news, while hard information releases are negative news. Taken as a whole, the results from theoretical and empirical research suggest disclosure could be increasing, constant, or even decreasing in firm performance. Further, the relation may vary across types of disclosure, particularly with respect to the legal cost motivation, because certain types of disclosure (or nondisclosure) may provide a more ready basis for lawsuits than others.10 2.2
DISCLOSURE AND FIRM SIZE

A relation between disclosure and firm size is expected if disclosure cost is decreasing in firm size. The notion that preparation costs are decreasing in firm size underlies much of the FASB's and SEC's consideration of firm size in mandating disclosure requirements.1" While the reason for the relation is not explicitly stated (and it seems unlikely that the total cost of disclosure is decreasing in firm size) it suggests that there may be a fixed component to disclosure cost, so that the cost

10For example, Skinner [1992] considers the legal incentives for releasing earningsrelated information preceding the formal announcement. It is not clear that the same incentives would exist for disclosures where the information is less concrete and will not become publicly available for some time, if ever. Further, survey evidence suggests that managers perceive less legal risk in direct communications with analysts than in public disclosures of forecasts (Lees [1981]). " For example, small firms were exempted from the disclosure requirements of SFAS No. 89: Financial Reporting and Changing Prices and the SEC has separate 10K and 10Q filing requirements for small firms, labeled 10KSB and 1OQSB, in an attempt to lighten the burden of accessing the equity markets (see the Wall StreetJournal [November 26, 1991]). While these are mandatory disclosures, a similar relation between firm size and disclosure costs would be expected for the preparation costs of voluntary disclosures.

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per unit of size is decreasing. In addition, the cost of disseminating disclosures may be higher for small firms because the news media are more likely to carry stories about large firms and analysts are more likely to attend their meetings.12 To the extent that costs are decreasing in firm size, the theoretical models discussed earlier predict that disclosure is increasing in firm size. An alternative reason to expect a relation between firm size and disclosure is provided in the transactions cost hypothesis of King, Pownall, and Waymire [1990], which predicts that disclosure will increase with firm size because the incentives for private information acquisition are greater for large firms (where the profit to trading on private information is higher). Further, consistent with the legal cost hypothesis in Skinner [1992], disclosure may increase in firm size because dollar values of damages in securities litigation are a function of firm size. Empirical evidence on the relation between firm size and earnings forecasts (e.g., Cox [1985], Waymire [1985], and Lev and Penman [1990]) indicates that more earnings forecasts are reported in the financial press for large firms than for small firms. Atiase [1985] and Freeman [1987] provide evidence that a greater proportion of earnings information is impounded in stock prices prior to earnings announcements for large firms than for small firms, suggesting that the amount of information provided by and about firms is increasing in firm size. 2.3
DISCLOSURE AND PERFORMANCE VARIABILITY

Disclosure may be related to the variability of firm performance if performance proxies for information asymmetries between investors and managers. For instance, if managers have prior access to performance information, the variability of past performance measures the unpredictability of performance and, hence, the potential information asymmetry. Because the severity of the adverse selection problem increases with information asymmetry, disclosure will be increasing in the information asymmetry between managers and investors. Alternatively, if performance variability captures information to which management does not have prior access, performance variability will be negatively correlated with information asymmetry and, consequently, negatively correlated with disclosure. Anecdotal evidence suggests that disclosures increase when perceived management/investor information asymmetry is high. For example, biotechnology firms appear to disclose considerable nonrequired information because the information asymmetry between managers and investors is high and traditional mandatory disclosures are unlikely to capture
12 O'Flaherty [1984] discusses practical issues associated with attracting investor and analyst attention.

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value-relevant information (Cohen [1992]). Further, survey evidence indicates that one common motivation for management earnings forecasts is to correct deviations between management's assessment of earnings prospects and the market's (Lees [1981] and Ajinkya and Gift [1984]). Finally, return volatility may be related to disclosure because of its effect on firms' vulnerability to legal action. In particular, damages in securities fraud cases are normally based on share price changes and large share price fluctuations may, themselves, draw lawsuits (Alexander [1991]). Firms with volatile stock prices may increase disclosure to reduce the incidence of large one-time stock price changes, thus preempting suits based on failure to disclose required information in a timely manner. Empirical research has focused primarily on the relation between management earnings forecast frequency and earnings volatility, with mixed results. Imhoff [1978], Cox [1985], and Waymire [1985] provide evidence that firms with less volatile earnings are more likely to provide earnings forecasts, but Lev and Penman [1990] find no relation between disclosure frequency and earnings volatility.

2.4

DISCLOSURE AND THE CORRELATION BETWEEN RETURNS AND EARNINGS

The correlation between annual returns and earnings may proxy for information asymmetry; a low correlation indicates that little information about firm value is captured by the mandatory earnings disclosure, so the remaining asymmetry is high. Alternatively, under the transaction cost hypothesis of King, Pownall, and Waymire [1990], a high correlation provides an incentive for private information acquisition about current earnings since earnings are highly correlated with returns. Under this scenario, managements of firms with high correlations would tend to disclose more to reduce incentives for private information
acquisition.

2.5

DISCLOSURE AND SECURITY ISSUANCE

Survey evidence suggests that managers consider the need to attract new capital to be a primary motivation for issuing earnings forecasts (Lees [1981]). Similarly, Gibbins, Richardson, and Waterhouse [1990] find, based on interviews, that the frequency with which firms issue securities influences their disclosure policies. The more weight managers place on maximizing current firm value, the greater their incentive to disclose positive information prior to a security offering. In addition, managers may disclose more information prior to securities offerings to reduce the informational asymmetry which would otherwise cause the offering to be a negative signal about firm value (Leland and Pyle [1977] and Myers and Majluf [1984]). Finally, more disclosure increases the pool of potential investors in the new securities and, hence, the equilibrium price (Merton [1987] and Fishman and Hagerty [1989]).

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Partially offsetting the incentives to increase disclosure prior to securities offerings are restrictions imposed during the "prefiling period," that is, from the time a securities offering is anticipated until a registration statement is filed (see Jennings and Marsh [1987, pp. 69-84]). During this period, firms are limited in terms of the new disclosures they may initiate (particularly with regard to projections and opinions) but may continue their regular disclosure programs (including unstructured disclosures), respond to legitimate inquiries for information about the business, and disclose factual business developments. Empirical evidence on the relation between management earnings forecasts and security issuance suggests that firms which offer securities are more likely to issue earnings forecasts. Ruland, Tung, and George [1990] and Frankel, McNichols, and Wilson [1992] find that the frequency of management earnings forecasts increases prior to securities offerings. 2.6
SUMMARY

While the preceding discussion suggests reasons to expect the variables considered in this paper to be correlated with disclosure, the direction of the relation is not always clear. Most existing research and anecdotal evidence suggests a positive association between disclosure and size or security issuance, but the relation between disclosure and performance level, performance variability, and the earnings/return correlation may be situation specific.

3. Disclosure Data
Our data on analysts' perceptions of corporate disclosures are taken from the 1985-89 FAF Reports. These reports, prepared by industrycontain evaluations of the adequacy of specific analyst subcommittees, firms' disclosures along three dimensions: annual published information, quarterly and other published information, and investor relations and related aspects. Within the three categories, each industry subcommittee prepares a list of important aspects of disclosure weighted to reflect information requirements in the industry and assigns a score to each firm.13 The total company score is a weighted combination of the three category scores. Briefly, in the "Annual Published Information" category, analysts assess the clarity and candidness of the financial highlights and president's letter; the amount of detail about the corporate officers, the corporation's goals, and product and geographic segments; and the overall level of detail in the financial statements and footnotes. In the "Quarterly and Other Published Information" category, analysts consider the depth of
13A complete list of criteria each committee considers FAF Report and is available from the authors on request. is given in the appendix of the

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coverage in quarterly reports and the availability of other written material, such as press releases, proxy statements, summaries of the annual meeting proceedings and presentations to analyst groups, and statistical supplements. The amount of segmental detail provided in the quarterly reports is the most frequently mentioned item in this category. In the "Investor Relations" category, analysts assess how knowledgeable and responsive the company contact is to analyst questions, the accessibility of and managers and their candor in discussing corporate developments, the frequency and content of presentations to analysts. For approximately 19% of the industries (38% of the firms) the FAF Reports contain only the overall company scores, and for approximately 5% of the industries (5% of the firms) the reports contain only rank values, either category and overall ranks or overall ranks alone.14 Thus, on whether total the composition of the sample varies depending scores or individual category scores are used in the analysis. Table 1 lists the industries evaluated at least once during the five-year sample period and the number of total firm-years in each industry. The FAF data represent a cross-section of industries, including service, manuand extraction. Banking provides facturing, financial, transportation, 20% of the total score observations, although this industry subcommittee does not report individual category scores. The evaluation process begins with the selection of leading analysts to serve on the industry subcommittees.15 Each subcommittee meets to choose the criteria in each category and their weights, as well as the firms to be evaluated.16 After the evaluations are complete, each subcommittee typically meets again to summarize their scores, prepare a written justification of the results, and decide whether to recommend that the top company in their industry receive an Award for Excellence in Corporate Reporting. Finally, the report is mailed to all the firms meets individually with surveyed and in many cases the subcommittee company representatives to discuss the results. The preceding discussion and a reading of the FAF Reports suggest that analysts commit substantial time and resources to evaluating the
14 The Financial Services subcommittee reported the percentage of possible points for each category except for annual published information. Because they did not report category weights, we could not infer the annual publications score. '5A casual comparison of the analysts included on the subcommittees with those selected for the Institutional Investor "All-American Research Team" suggests a substantial overlap. For example, in 1988, three of the five analysts on the airline subcommittee and ten of the eighteen analysts on the chemical subcommittee were members of the 1988 All-American Research Team. 16The industry subcommittees select firms based, in part, on size. For example, in 1988 the Banking committee selected the 100 largest banks based on year-end total assets; the Computers and Electronics committee selected the "twelve leading companies"; the Natural Gas committee reviewed the 11 largest distributors; the Savings Institutions committee selected the 12 largest companies based on year-end market capitalization, and the Software/Data Services committee selected all firms with market capitalization greater than $50 million.

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Industry Representation in the Financial Analysts Federation Coiporation Information Committee Report for Years 1985-89

Industry Aerospace Airline Apparel Banking Chemical Computer & Electronics Construction Container and Packaging Diversified Co. Oil-Domestic Oil-International Oil-Independent Oil-Service Oil-Drilling Oil-Service & Drilling Electrical Equipment Environmental Controls Financial Services Food

Number of Total Number of Total Years Firm-Years Industry Years Firm-Years 5 1 3 55 Beverage 5 1 4 66 Tobacco 5 1 27 48 Food, Beverage, and Tobacco 5 5 91 468 Healthcare 4 61 Healthcare Services 2 16 Insurance 5 130 28 2 23 5 94 2 Machinery 5 57 Motor Carrier 2 20 3 30 Natural Gas Distributors 5 52 5 Natural Gas Pipelines 5 66 52 5 35 Nonferrous and Mining 1 16 3 3 55 29 Paper and Forest 1 10 5 84 Publishing and Broadcasting 1 10 5 Railroad 37 4 44 Retail Trade 5 151 5 52 Savings Institutions 2 18 5 90 Software and Data Services 101 2 5 4 73 79 Specialty Chemicals 1 15 Textiles 5 29 Total 2,319

Note: In 1985 "Oil-Service" and "Oil-Drilling" reported as separate industries, but in 1986-89 they combined to report as "Oil-Service and Drilling." Similarly, "Food," "Beverage," and "Tobacco" reported separately in 1985 and then as "Food, Beverage, and Tobacco" in 1989.

firms and that the construct that they measure, "effectiveness of communication with investors," is closely related to the construct considered in previous research, the precision of the signal about firm value. Given that our empirical analysis treats the ratings as a measure of voluntary disclosure, however, it is important to consider the possibility of noise and bias in the evaluations. This research is similar to studies which investigate determinants of bond ratings in that we examine cross-sectional variation in expert opinions of an unobservable variable (see Foster [1986]). A primary difference is that, unlike the bond-rating literature, our interest is not in replicating the decision-making process of the analyst (which would involve incorporating specific disclosure items to explain cross-sectional variation in scores) but instead in using the scores as measures of disclosure and using economic determinants of disclosure to explain crosssectional variation in the scores. With respect to noise, industry analysts should be good judges of the adequacy of a firm's disclosures since, as some of the primary users, they have access to all of a firm's public disclosures, are able to assess the information needs in the industry, and have used the disclosed data during the year. Also, to the extent that errors in assessments are not perfectly correlated across analysts, the noise in the consensus judgment is likely to be dampened because each firm is assessed by

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more than one analyst.17 Further, the analysts organize the process themselves, choose the relevant criteria, voluntarily perform the evaluations, justify the results in writing, and present them to the compan, so it seems likely that they take care in producing their assessments.x With respect to analysts' incentives to report their perceptions accurately, the stated mission of the FAF Corporate Information Committee is to "actively encourage the improvement of reporting and disclosure practices of publicly-owned corporations" (1985 Report,p. 7). The creation and dissemination of the FAF Reportis the committee's primary vehicle for fulfilling its mission and the Reportis intended as a means of lobbying firms to provide effective disclosure. Bias in the ratings is a problem to the extent that it varies cross-sectionally with the variables of interest; if all scores are biased downward to encourage further disclosure or upward to curry favor with management, inference should not be affected. Further, individual analyst evaluations are not identified in the Report,reducing an individual's ability to gain a private advantage in his relations with management by biasing evaluations. Given that systematic bias may exist, however, care should be taken in drawing conclusions from the data.19

4. Results
4.1
DESCRIPTIVE STATISTICS AND SIMPLE RELATIONS

4. 1. 1. The Dependent Variables.The FAF data contain 751 firms (732 with Compustatdata) that are rated at least once in the five FAF Reports considered. Panel A of table 2 provides descriptive statistics for the three category scores and the total company score.20 The score for each category is a percentage (points received for the category divided
17While in most cases it appears that all firms in the industry are evaluated by all analysts in the subcommittee, in some cases firms are evaluated by a subset of analysts. For instance, in 1988 the Banking committee evaluated 100 firms and each company was scored by two analysts, and the Publishing and Broadcasting committee had at least nine analysts score each of the 15 companies. 15 Research in cognitive psychology indicates that "accountability to others of unknown views has been found in a number of studies to 'motivate' people to become more vigilant, complex, and self-critical information processors" (Tetlock [1985, p. 314]). 19While the FAF data are like survey data in that they are based on perceptions, the data differ in that the responses are not solicited by the researcher. Rather, the analysts organize the process, create the categories and criteria of evaluation, and publish the data. Consequently, many of the problems inherent in survey data-that the respondent's subordinates perform the task, that there is selection bias in the returned responses, and that the respondent's task involvement is low-are less likely to be present in the FAF data. 20 For convenience, in the discussion that follows, we sometimes refer to the analyst ratings as "disclosure scores" and the annual report, other publications, investor relations, and total categories from the FAF Report as "disclosure variables." It should be borne in mind, however, that these variables are based on analysts' perceptions of disclosure rather than the actual disclosures.

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Descriptive Statistics for Unadjusted Dependent and Independent Variables

Panel A: Dependent Variables-Analyst Ratings of Disclosure Categories Percentile n Mean 1% 25% 50% 75% Disclosure Category .73 .37 .75 .83 1,324 .64 Annual Report .70 .30 .60 .83 1,392 .72 Other Publications .77 .74 .64 .87 Investor Relations 1,392 .25 .80 2,272 .70 .32 .62 .72 Total Score Panel B: Independent Variables Variable Market-Adjusted Stock Return Deviation from Analyst Forecast Market Value ($ millions) STD(Stock Return) Return-Earnings Correlation Offer (a dummy variable) n 2,211 2,178 2,215 2,110 1,952 2,272 Percentile Mean 1% 25% 50% 75% .15 -.03 -.00 -.72 -.18 -.03 -.01 .01 -.68 -.03 2,438 .32 .32 33 .09 -.59 433 .20 .09 1,072 .26 .36 2,538 .36 .59

99% .95 .96 1.00 .95

99% .93 .12 20,794 1.20 .90

The four dependent variables are measured as the percentage of possible points received in each category. The Market-Adjusted Stock Return is the annual return less the market return for the fiscal year. The Deviation from Analyst Forecast is the actual earnings per share less the consensus forecast earning per share at the beginning of the fiscal year, divided by the price per share at the beginning of the fiscal year. Market Value is of outstanding equity at the beginning of the fiscal year. STD(Stock Return) is the standard deviation of market-adjusted returns, and the Return-Earnings Correlation is the correlation between annual earnings and annual stock returns, each computed for the ten years preceding the current FAFReportyear. Offer is a dummy variable equal to one if the firm files a debt or equity registration statement in the current fiscal year or in the next two fiscal years, and zero otherwise. In total there are 751 firms with at least one year of analyst ratings data during the years 1985-89.

by the number of points assigned to the category). This allows us to aggregate across industries with different weights assigned to the different categories. The percentage of total points, however, preserves the weights assigned by the different industry subcommittees. As seen in the table, all categories and the total score average slightly over 70% of the possible points. Each category has considerable variation; the difference between the 1st and 99th percentiles is highest for the investor relations variable (75%) and lowest for the annual report variable (58%), which may suggest that firms can more clearly differentiate their investor relations efforts than their annual report disclosures, perhaps because the former permit more discretion. Because each industry is evaluated separately by a different set of analysts, we industry-adjust all variables by subtracting the industry mean for the current year. Thus, the tests that follow should be interpreted as explaining intraindustry variation in analysts' ratings of disclosure with intraindustry variation in the independent variables.21 The three
21 The industry-adjustment has the advantage of removing cross-industry variation due to the different composition of industry committees, but it may also remove variation due to legitimate cross-industry variation in disclosure. Conclusions from an analysis of

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industry-adjusted disclosure categories are all significantly correlated with one another at the .0001 level, using rank-order correlations. The annual report-other publications correlation is .62, the annual report-investor relations correlation is .41, and the other publicationsinvestor relations correlation is .48. The significant correlation levels suggest that firms coordinate their disclosure policies across the different types of communication (or that analyst biases in evaluation are similar across categories). However, the fact that the correlations are considerably less than one suggests that the categories may capture different aspects of disclosure, as perceived by analysts. 4.1.2. The Independent Variables. For expositional purposes, we divide our independent variables into three groups. The "structural" variablesfirm size and the historic standard deviation of market-adjusted annual returns and earnings/returns correlation-are likely to be fairly stable over time. The "performance" variables-abnormal returns and unexpected earnings-are likely to vary substantially year to year. The "offer" variable is based on the extent to which firms issue securities and is likely to be more stable than the performance variables but more variable than the structural variables.22 Firm size is the market value of outstanding equity at the beginning of the year. The variation in returns is the standard deviation of marketadjusted annual returns over the preceding ten years and the earnings/ returns correlation is the correlation between annual earnings and annual market-adjusted returns over the preceding ten years.23 The annual market-adjusted stock return and the analyst forecast error are based on the median analyst forecast of earnings from the IBES summary tape as of the beginning of the fiscal year, deflated by the return meaprice at the forecast date. The annual market-adjusted sures a broader range of performance than current-period earnings but is partly endogenous because it may reflect the disclosure policy of the firm (as distinct from the disclosures themselves). While the deviation

the unadjusted variables presented in an earlier draft of this paper are very similar to, and generally stronger than, those reported here. 22 The empirical analysis suggests that the sample firms which issue securities tend to do so repeatedly. Further, a decision to issue securities in the future may affect disclosure choice for a significant period prior to the sale (Frankel, McNichols, and Wilson [1992]), perhaps reflecting legal restrictions on increased disclosure during the registration period. The offer variable also differs from the structural and performance variables because it is partially under the control of management. 23 In an earlier draft, we also considered the standard deviation of return on equity over the preceding ten years and the standard deviation of analyst forecasts in the current year. Both were highly correlated with the standard deviation of returns and yielded similar results. 24 Market-adjusted returns are computed from the CRSPdata by subtracting the valueweighted market return from the return on the firm's stock, computed over its fiscal year.

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from the analyst forecast measures only earnings performance, it is an exogenous measure since the current year's forecast is made prior to the year's disclosures.25 In addition to the current year's performance variables, we also consider the measures for the preceding year and, for the deviation from analyst forecasts, the subsequent year as well. We consider the lead and lag performance variables because the prediction that disclosure increases with performance, given by the adverse selection model, requires that performance be known to the firm but not of next year's perforforeknowledge outside parties. Management mance is one way such an information asymmetry could arise. Another possibility is that managers may know only past performance but, as in the model of Fishman and Hagerty [1989], outside parties become aware of the past performance only if the firm lowers the cost of becoming informed by increasing its disclosure. Finally, as a measure of a firm's activity in the securities markets, we use an index variable to identify firm-years with a debt or equity offering in the current or following two years (27% of the sample). Offering data are collected from the Investment Dealer's Digest [1985; 1987; 1990], which provides a complete listing of SEC registration statement filings for the current and preceding two years. We include offerings which take place in future years to reflect increased disclosure in anticipation of future securities issues.26 Panel B of table 2 provides descriptive statistics for the firm's financial statement and stock market variables. The sample has a median equity market value of approximately one billion dollars and an interquartile range of over two billion dollars, indicating that, while the average sam le firm is large, there is substantial cross-sectional variation in size. The mean market-adjusted stock return for the period is negative, as is the deviation from analyst forecasts, suggesting that, on average, bad news was revealed during the period for the sample firms. for the industrycorrelations Table 3 provides the rank-order variables. In general, the absolute correlation adjusted independent between the three structural variables and between the two performance variables is higher than the correlations across the two groups.
25 We also considered return on equity and return on assets as performance measures, with very similar results. 26 There are 613 firm years in our sample with an offering in the current or following two years, of which 579 are debt offerings. Frankel, McNichols, and Wilson [1992] argue that incentives for increased disclosure may be greatest for debt offerings and provide evidence that the increase in frequency of management earnings forecasts prior to security offerings is greater for debt offerings than for equity offerings. We also conducted the analysis using the offer variable defined to exclude the current year to control for the fact that mandatory disclosures increase with public offerings, with very similar results. 27 Given that the average firm in the sample is large, care should be exercised in generalizing the results to small firms.

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TABLE 3 Rank-Order Correlations between Firm Characteristics (The sample is composed of firms that are rated in at least one of the Financial Analysts Corporate Information Committee Reports during 1985-89. Listed below each correlation is the p value.) STD(RET) CORR DEV Lag 1 DEV DEV Lead 1 RET LagI RET OFFER

Market Value

-.247 (.0001)

-.089 (.0001)

.094 (.0001)

.065 (.0026)

.078 (.0004)

.103 -.013 (.0001) (.5466)

.182 (.0001) -.065 (.0027) .037 (.1025) -.009 (.6890) -.012 (.5877) .012 (.5702) .000 (.9998) .020 (.3419)

STD(RET)

-.037 .387 -.068 -.048 -.006 -.027 (.0001) (.2207) (.0021) (.0324) (.7745) (.0910) -.068 -.066 -.078 -.014 -.029 (.0029) (.0038) (.0007) (.1968) (.5387) .315 (.0001) .283 (.0001) .339 (.0001) .352 (.0001) .217 (.0001) .137 (.0001) .168 (.0001) .386 (.0001) .231 (.0001) .045 (.0362)

CORR

DEVLag 1

DEV

DEVLead 1

RET Lag 1

RET

Market Value is of outstanding equity at the beginning of the fiscal year, STD(RET) is the standard deviation of annual market-adjusted stock returns, and CORRis the correlation between annual stock returns and annual earnings, each computed for the ten years prior to the current year. DEV is the actual earnings per share less the consensus forecast earning per share at the beginning of the fiscal year, divided by the price per share at the beginning of the fiscal year, RET is the annual marketadjusted stock return, and leads and lags are for one fiscal year in the future and in the past, respectively, relative to the year covered by the FAF Report.All variables are industry-adjusted by subtracting the industry mean for the year. OFFERis a dummy variable equal to one if the firm files a debt or equity registration statement in the current fiscal year or in the next two fiscal years, and zero otherwise. The number of observations ranges from 1,854 to 2,231.

This suggests that the structural variables and the performance variables are capturing different phenomena, and that collinearity within the sets of structural or performance variables may be an issue while collinearity across the different sets of variables is probably not. The right-most column in table 3 gives the rank-order correlation between the structural and performance variables and an indicator variable identifying the security offering and nonoffering subsamples (the significance levels are equivalent to Wilcoxon tests comparing the medians of the offering and nonoffering subsamples). The offering subsample of firm-years has a significantly higher market value, lower corvariation in market-adjusted returns, and higher earnings-returns

DETERMINANTS

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relations than the nonoffering subsample. There is not a significant relation between the offering and performance variables.28 Rank-order correlations between each disclosure measure and the independent variables are provided in table 4. The score for each disclosure category is increasing in the firm's performance and size, decreasing in the earnings-returns correlation and the standard deviation of returns, and higher for the offering subsample. Further, the strength of the relation between the disclosure scores and deviations from analyst forecasts is relatively constant across the lag, current, and lead values, while the correlation between the disclosure scores and returns is uniformly higher for the current return than the lag 1 return. Because the current performance variables are generally more highly correlated with the disclosure scores than are the lead and lagged performance variables and the various lags and leads are highly correlated with each other, for parsimony we include only the current deviation from analyst forecasts and current returns in the regressions that follow.29
4.2
REGRESSION ANALYSIS

To examine the incremental explanatory power of the variables, we estimate multiple regressions. Because the variables within the structural and performance constructs are correlated, we first estimate reduced regressions using only one structural variable, one performance variable, and the offering variable. We then estimate a full regression model using three structural variables, two performance variables, and the offer variable. Finally, because a firm's residuals may not be independent across years, we estimate the regressions using only one observation per firm. Results (not reported) for the regressions based on one observation per firm are generally very similar to those reported in tables 5 and 6. Given that the theoretically correct form of the relation between the analyst ratings of disclosure and the independent variables is not known, we use rank regressions in analyzing the data. This nonparametric technique involves ranking the dependent and independent variables and then estimating an OLS regression using the rank-transformed data. If the relation between the dependent variable and the independent variables is monotonic, a higher-ranked independent variable will correspond to a higher-ranked dependent variable, regardless of the precise
28 Previous research suggests that firms tend to issue securities following share price increases (Lucas and McDonald [1990]). However, our returns are market- and industryadjusted and are measured annually, while the sensitivity of offering to performance is likely to arise within shorter time spans. 29The results are generally quite similar if the current earnings variable is replaced with the lead or lagged earnings variable or if the current returns variable is replaced with lagged returns. The lead or lagged performance variables are typically not significant conditional on current performance.

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MARK LANG AND RUSSELL LUNDHOLM

TABLE

Rank-Order Correlations between Analyst Ratings of Disclosure as Given in the Financial Analysts Federation Corporate Information Committee Report during 1985-89 and Firm Characteristics Percentage of Possible Points in Investor Total Annual Other Relations Score Report Publications Market Value 0.1624 (0.0001) 1,287 0.0918 (0.0007) 1,352 0.1290 (0.0001) 1,352 0.1882 (0.0001) 2,169 correlation pvalue number of observations

Return-Earnings

Correlation

-0.1289 (0.0001) 1,192 -0.0753 (0.0077) 1,251 0.0700 (0.0136) 1,244 0.0622 (0.0268) 1,266 0.0869 (0.0021) 1,247 0.0264 (0.3482) 1,269

-0.1231 (0.0001) 1,241 -0.0677 (0.0144) 1,306 0.0394 (0.1552) 1,302 0.0460 (0.0938) 1,329 0.0675 (0.0145) 1,311 0.0384 (0.1617) 1,328 0.0576 (0.0343) 1,350 0.1473 (0.0001) 1,392

-0.0947 (0.0008) 1,241 -0.0278 (0.3159) 1,306 0.0920 (0.0009) 1,302 0.0969 (0.0004) 1,329 0.1044 (0.0002) 1,311 0.0984 (0.0003) 1,328 0.1430 (0.0001) 1,350 0.1000 (0.0002) 1,392

-0.0915 (0.0001) 1,910 -0.0669 (0.0024) 2,066 0.0648 (0.0032) 2,065 0.0896 (0.0001) 2,132 0.0821 (0.0002) 2,109 0.0642 (0.0031) 2,121 0.0892 (0.0001) 2,165 0.1732 (0.0001) 2,272

STD(Stock Return)

Deviation from Analyst Forecast Lag 1

Deviation

from Analyst Forecast

Deviation from Analyst Forecast Lead 1

Market-Adjusted Return Lag 1

Stock

Market-Adjusted

Stock Return

0.0607 (0.0297) 1,285 0.1575 (0.0001) 1,324

Offering

Market value of equity is measured at the beginning of the fiscal year, STD (Stock Return) is the standard deviation of annual market-adjusted stock returns, and the return-earnings correlation is between annual stock returns and annual earnings, each computed for the ten years prior to the current year. The Deviation from Analyst Forecast is the actual earnings per share less the consensus forecast earning per share at the beginning of the fiscal year, divided by the price per share at the beginning of the fiscal year, Market-Adjusted Stock Return is the annual market-adjusted stock return, and leads and lags are for one fiscal year in the future and in the past, respectively, relative to the year covered by the FAF Report. All variables are industryadjusted by subtracting the industry mean for the year. The offering variable equals one if the firm files a debt or equity registration statement in the current fiscal year or in the next two fiscal years, and zero otherwise.

DETERMINANTS

OF ANALYST RATINGS

263

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264

MARK LANG AND RUSSELL LUNDHOLM TABLE 6

Full Regressions Using Analyst Ratings of Disclosure as Given in the Financial Analysts Federation Corporate Information Committee Report during 1985-89 (The p value for a two-tailed t-test is listed beneath each coefficient estimate) Category MKTVAL CORP STD(RET) DEV RET OFFER

Annual Report

.175 (.0021) .098 (.0014) .201 (.0001) .211 (.0001)

-.100 (.0015) -.111 (.0004) -.088 (.0038) -.077 (.0014)

.032 (.3329) .049 (.1391) .087 (.0074) .040 (.1231)

-.017 (.5956) .038 (.2237) .029 (.3375) -.031 (.2085)

.094 (.0026) .055 (.0734) .123 (.0001) .084 (.0007)

.077 (.0002) .099 (.0001) .061 (.0023) .086 (.0001)

Other Publications

Investor Relations

Total Score

Each regression has an intercept term, which is always significant, and the six independent variables listed across the top of the table. With the exception of the OFFER dummy variable, all variables are ranked smallest to largest within their industry (defined by the FAF Report)for the current year and then converted to percentiles, defined as (rank - 1)/(number of firms in the industry - 1). The four dependent variables, listed by their category names in the left-most column, are the analyst disclosure scores. MKTVALis the market value of the firm at the beginning of the fiscal year, STD(RET) is the standard deviation of annual market-adjusted stock returns, and CORR is the correlation between annual stock returns and annual earnings, each computed for the ten years prior to the current year. DEVis the actual earnings per share less the consensus forecast earning per share at the beginning of the fiscal year, divided by the price per share at the beginning of the fiscal year, and RET is the annual market-adjusted stock return. OFFER a dummy variable equal to one if the firm files a debt or equity is registration statement in the current fiscal year or in the next two fiscal years, and zero otherwise. The Annual Report, Other Publications, Investor Relations, and Total Score regressions have 1,187, 1,235, 1,235, and 1,889 observations, respectively.

relation between the two variables.30 To maintain the industry-adjustment for both the independent and dependent variables, we rank variables within their industry-year and, because there are different numbers of firms in each industry, we convert the ranks to percentiles: (rank - 1)/(number of firms - 1). This conversion yields the percentile of the firm's rank within its industry, so that the lowest-ranking firm in the industry receives a zero and the highest-ranking firm receives a one. The regression is then estimated using the percentiles as independent and dependent variables. Table 5 presents the results from the regressions using each combination of one structural variable, one performance variable, and the offering variable, and using all the data. With the exception of the standard deviation of past returns for the other publications and investor relations scores, all coefficients in all regressions are significant at conventional levels and have the same signs as the corresponding simple correlations. In addition, the relations appear to vary across the catego30 With only one independent variable this technique is equivalent to estimating the rank-order correlation. Iman and Conover [1979] show that rank regressions are quite powerful when the relations are nonlinear but monotonic.

DETERMINANTS

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265

ries of disclosure. Specifically, the annual report scores are most strongly associated with the structural variables, the investor relations scores are most strongly associated with the performance variables, and the other publications scores are most strongly associated with the offer variable. One possible explanation for the pattern is that investor relations are most flexible and, hence, most sensitive to short-term changes in incentives to disclose, while the annual report is more rigid and determined by longer-term characteristics of the firm. The relation between the offer variable and the other publications scores may, in part, reflect a desire to have an extensive disclosure program in place prior to a public offering, when increased disclosure is prohibited. Table 6 provides results from the full regression. The market value, returns, and offering variables are always significantly positive and the earnings/returns correlation variable is always significantly negative. The deviation from analyst forecasts is never significant, suggesting that returns capture the relevant information in earnings.31 The preceding analysis assumes that each firm-year can be treated as an independent observation. To the extent that the explanatory variables do not remove all autocorrelation in the dependent variables, the degrees of freedom in calculating the significance levels are overstated. Given that there are on average three observations per firm in our sample, in the worst case the degrees of freedom are overstated by a factor of three. Dividing the degrees of freedom by three would not significance materially alter our conclusions from table 6-reported levels of less than .0044 would remain significant at the 10% level and only two coefficients (the coefficients on returns for other publications and on the standard deviation of returns for investor relations) would no longer be significant at the 10% level. An alternative approach is to reestimate the regressions allowing each firm to appear only once. For each firm we compute the mean value of the independent and dependent variables and construct a "mean" offering subsample that includes those firms that file a registration statement in any year in the FAF sample or two years thereafter. 32
31The coefficient on the standard deviation of returns is positive, although generally not significant. This result is inconsistent with the simple relations shown in table 4 and expectations based on previous empirical research, which has found a negative relation between the frequency of management earnings forecasts and performance variability. It is possible that the standard deviation of returns is a proxy for information asymmetry and that managers attempt to mitigate the asymmetry through increased disclosure of the type captured by the FAF data, rather than making management earnings forecasts. 32We compute the mean of the percentile for each variable in the model, but an alternative would be to first compute the means of the raw data and then convert the means to percentiles. Our approach uses data from industries that reported only disclosure ranks, which would be lost under the alternative approach. In addition to estimating the regression for means of the dependent and independent variables, we estimated the full regressions year by year to verify that the results are consistent across years. We also conducted the analysis for a sample using only the first year that a firm appeared in

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MARK LANG AND RUSSELL LUNDHOLM

Results (not reported) from these reduced regressions using only one observation per firm are very similar to the results from the reduced regressions using all the data. The market value, earnings/ returns correlation, offering, and returns variables are significant at the 10% level in all regressions and have the same sign as in the regressions using all the data. The deviation from analyst forecasts is insignificant for the annual report category but significant for all but one other regression. The standard deviation of past returns is insignificant in all regressions, but it has the same sign as in the regressions using all the data. Results (not reported) from the full regression with one observation per firm yield coefficients whose signs are consistent with the regressions reported in table 6. The offering variable is significant at the 10% level for all categories, market value and returns are significant for all but the other publications category, and the earning/returns correlation is significant for the other publications and investor relations categories. Consistent with the regressions using all the data, the standard deviation of past returns and the deviation from analyst forecasts are insignificant. We perform two other specification checks on the regressions. First, because the adverse selection model and the legal cost hypothesis predict that the relation between disclosure and performance is nonlinear, that allow different coefficients for perforwe estimate regressions mance in the first quartile, in the second quartile, and above the median. While there is some evidence that the relation between disclosure scores and performance is stronger for performance above the median, we cannot reject the hypothesis that all three coefficients are the same at the .10 level for any disclosure category or performance variable. Second, to investigate the possibility that firms are completely insensitive to their current price when not issuing securities, and the significant performance and structural relations are driven entirely by the offering subsample, we estimate the regressions using only the nonoffering subsample. The results for the nonoffering subsample are similar to those reported in tables 5 and 6. 4.3
ANALYSIS OF CHANGES IN DISCLOSURE LEVELS

The scores. sions scores, scores

results thus far have focused on the level of the disclosure Because it is possible that variables omitted from our regresand correlated with the included variables affect disclosure we also examine the association between changes in disclosure and the independent variables.

the sample and a sample using only the last year. In general, the results from these analyses are similar to those reported in the paper, suggesting that the conclusions are not unduly influenced by any individual year.

DETERMINANTSOF ANALYST RATINGS

267

Our data are not ideally suited to this approach for several reasons. First, most of the independent variables exhibit little variation over the five years we consider. The structural and offer variables are unlikely to vary much from year to year, particularly for the standard deviation of returns and the earnings/returns correlation which are computed over ten years. Second, firms' disclosure policies may be "sticky"from year to year. For instance, casual observation of annual reports suggests that their general content remains relatively constant over time, perhaps reflecting auditor hesitancy to allow substantial year-to-year variation in annual report content. While the investor relations effort is likely to be more flexible, large-scale, short-term changes in the investor relations department are likely to be costly. Finally, we have at most five consecutive years of disclosure data from which to compute chan es and only 18% of the 751 firms have complete data for all five years. 3 We focus our analysis on the performance variables because they have the most variability during our sample period. In addition, we compute changes over periods of one to four years to allow for a gradual adjustment in firms' disclosure policies. As in the cross-sectional analysis, it is unclear whether concurrent changes, lag changes, or lead changes are the best specification of performance. We focus primarily on lead changes, under the assumption that the firm changes its current-period disclosures based on expectations about future performance. Hence, we correlate the change in disclosure scores over an n-year window with the sum of the deviations from analyst forecasts and the market-adjusted stock return for the n-year window shifted one year into the future. Because each firm now acts as its own control,
we no longer adjust the variables by their industry means.34 Table 7 presents the rank-order correlations between the changes in variables for the disclosure scores and the changes in performance different window lengths. The results vary over the different performance measures and, while weak overall, are significant at conventional levels for the investor relations and total scores and generally strengthen as the window length increases. The changes in total scores are significantly correlated with the deviation from analyst forecasts for all window lengths and with stock returns for all but the one-year window. The

33Another potential problem with analyzing changes in disclosure scores is that the membership of the analyst committee (and potentially the weights and criteria used in evaluating the firms) may change over time. While such changes could affect the levels analysis as well, it is particularly an issue here because there tends to be less time-series variation in scores than cross-sectional variation and, hence, noise may comprise a larger proportion of total variation in comparisons over time. 34We use the sum of deviations from analysts' one-year-ahead forecasts rather than a single n-year-ahead forecast error because forecasts for horizons beyond one year are infrequent. The results using changes in industry-adjusted disclosure variables are very similar. The results for concurrent windows and one-year lagged windows are weaker than, but qualitatively similar to, those based on the one-year-ahead windows.

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MARK LANG AND RUSSELL LUNDHOLM

TABLE 7 Rank-Order Correlations between Changes in Analyst Ratings of Disclosure as Given in the Financial Analysts Federation Corporate Information Committee Reports during 1 985-89 and the Deviations from Analyst Forecasts and Stock Returns (Listed below each correlation is the p-value)

Change in Disclosure Score over Period Other Annual Report Publications ZDEV4 years 0.144 0.121 (0.096) (0.164) ZDEV3 years 0.101 (0.078) 0.119 (0.007) 0.091
(0.009)

Investor Relations 0.219 (0.011) 0.160 (0.005) 0.163 (0.000) 0.075

(0.026)

Total 0.225 (0.001) 0.166 (0.000) 0.137 (0.000) 0.063

(0.018)

Number of Observations 134/134/233

0.092 (0.106) 0.086 (0.045) 0.089

(0.009)

303/312/524

ZDEV2 years

509/542/882

1DEV1 year

812/878/1,415

RET4 years

0.047 (0.610) 0.026 (0.655) -0.019

(0.677)

0.158 (0.086) 0.059 (0.309) 0.054

(0.219)

0.212 (0.021) 0.199 (0.001) 0.148

(0.001)

0.180 (0.008) 0.130 (0.003) 0.097

(0.004)

119/119/218

RET3 years

289/298/510

RET2 years

495/527/871

RET 1 year

-0.014 (0.693)

0.024 (0.491)

0.002 (0.959)

0.024 (0.362)

794/858/1,390

ZDEV niyears is the lead I sum of earnings deviations from analyst forecasts made at the beginning of each fiscal year over n fiscal years, and RET n years is the lead 1 stock return for n fiscal years. The number of observations for the annual report category is listed first, the number for the other publications and investor relations categories is listed second, and the number for the total score is listed third.

results are less consistent for the annual report and other publications scores, where the deviation from analyst forecasts is significantly correlated with changes in the disclosure scores for all four window lengths, but there is only one significant relation for the stock return variable. Of the three disclosure categories, investor relations scores are the most strongly related to performance, perhaps because investor relations are the most flexible of the three categories over relatively short time periods. The inconsistent results for the annual report and other publications scores suggest that these categories are less flexible over short time periods.

5. Conclusions and Interpretation

In this paper we have investigated determinants of voluntary disclosure choice, as measured by disclosure scores prepared by the Financial

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269

Analysts Federation. The empirical results are generally consistent with existing research on voluntary disclosure choice. For example, disclosure scores are higher for firms that perform well (particularly in terms of stock returns), for larger firms, for firms with a weaker relation between annual stock returns and earnings, and for firms that issue securities. The relation between disclosure scores and return variability is weak, particularly after controlling for other factors, such as firm size. The result that disclosure scores increase in firm size and security issuance is consistent with much of the existing research on voluntary disclosure. The relations between disclosure scores and performance are generally consistent with the adverse selection motive for disclosure and with the early research on management forecasts. The negative relation between the earnings/returns correlation and disclosure scores is consistent with the earnings/returns correlation capturing information asymmetry in the context of an adverse selection model. The relations between the disclosure scores and firm characteristics vary across types of disclosure. Although we do not explicitly test for differences across disclosure categories, the results suggest that the investor relations scores are most sensitive overall to the variables considered in this study, particularly the performance variables, while the annual report and other publication scores are most sensitive to the structural and offer variables. That result is consistent with the notion that investor relations are characterized by more managerial discretion and short-term flexibility, while the annual report and other publications are more rigid. Beyond providing evidence on the specific hypotheses considered here, we also describe an interesting data base of analysts' perceptions of firms' disclosures. Although previous research has studied particular disclosure choices, such as voluntary management earnings forecasts, relatively little is known about firms' overall disclosure choices, primarily because of the difficulty in obtaining a comprehensive proxy for firms' voluntary disclosures. As mentioned previously, however, use of these disclosure scores is not without its dangers, particularly because the data are based on analysts' ratings rather than the disclosures themselves. To the extent that analysts' ratings are biased and the bias varies cross-sectionally with the independent variables of interest, care should be exercised in interpreting the results.

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