Transcript Payout Policy in the 21st Century

October 2004
Q-Group Fall Conference,
La Quinta Resort & Club
The Economic Implications of
Corporate Financial Reporting
John R. Graham
Duke University, Durham, NC USA
Campbell R. Harvey
Duke University, Durham, NC USA
National Bureau of Economic Research, Cambridge, MA USA
Shiva Rajgopal
University of Washington, Seattle, WA USA
1
Graham/Harvey/Rajgopal: Corporate Reporting
Background
1. Graham and Harvey conduct a survey on capital
structure and project evaluation
– “Theory and Practice of Corporate Finance: Evidence from
the Field” appears in JFE 2001
2. Brav, Graham, Harvey & Michaely survey on
dividend and repurchase policy
– “Payout Policy in the 21st Century” forthcoming in JFE
2004
3. Graham, Harvey and Rajgopal survey on corporate
financial reporting
2
Graham/Harvey/Rajgopal: Corporate Reporting
Methodology
General goals our research program:
• To examine assumptions
• To learn what people say they believe
• To provide a complement to the usual research
methods: archival empirical work and theory
3
Graham/Harvey/Rajgopal: Corporate Reporting
Methodology
Approach contrasts with Friedman’s (1953) “The
Methodogy of Positive Economics”
• Goals of positive science are predictive
• Don’t reject theory based on “unrealistic
assumptions”
• Also, rejects notion that all the predictions of a
theory matter to its validity – goal is “narrow
predictive success”
4
Graham/Harvey/Rajgopal: Corporate Reporting
Narrow goals
Insight on following issues:
• Importance of reported earnings and earnings
benchmarks
• Are earnings managed? How? Why?
– Real versus accounting earnings management
– Does missing consensus indicate deeper problems?
• Consequences of missing earnings targets
• Importance of earnings paths
• Why make voluntary disclosures?
5
Graham/Harvey/Rajgopal: Corporate Reporting
Strengths and limitations
Strengths:
• Surveys enable us to ask decision-makers specific qualitative
questions about motivations
• Less of a variable specification problem
• Complements large sample analyses
• A unique angle to confront theories with data
Limitations:
• Questions may be misunderstood
• Truthful responses?
• Non-response bias
• Friedman (1953)
6
Graham/Harvey/Rajgopal: Corporate Reporting
Method
Survey and Interview Design
• Draft survey instrument “refereed” by both finance
and accounting researchers as well as experts in
survey design
• Interviewed structured to adhere to best scientific
practices of interviews, e.g. Sudman and Bradburn
(1983)
• IRB certification for human subject research
7
Graham/Harvey/Rajgopal: Corporate Reporting
Sample
• 401 usable survey responses
– response rate of 10.4%
• 25% response rate at a practitioner conference
• 8% response rate to Internet survey
• Interview 20 CFOs
– 40-90 minutes in length
– More give and take than in the survey
– Interviewed firms are much larger, more levered and more
profitable than the average Compustat firm.
• Relative to Compustat firms
– Surveyed firms are larger, more levered, greater dividendyield, fewer firms report negative earnings
– Similar B/M and positive P/E
8
Graham/Harvey/Rajgopal: Corporate Reporting
Sample
Firm characteristics (self reported)
• Agency
– CEO age, tenure, education
– Inside ownership
• Size
– Revenues
– Number of employees
• Growth opportunities
– P/E
– Growth in earnings
9
Graham/Harvey/Rajgopal: Corporate Reporting
Sample
Firm characteristics (self reported)
• Free cash flow effects
– Profitability
– Leverage
• Informational effects
– Public/private
– Which stock exchange
• Industry
• Credit rating
10
Graham/Harvey/Rajgopal: Corporate Reporting
Sample
Firm characteristics (self reported)
• Financial reporting practices
– Number of analysts
– Do they give “guidance”?
• Ticker symbol!
11
Corporate Financial Reporting
Performance measurements
(earnings, cash flows): Sec 3.1,Table 2
Earnings
benchmarks
Sec 3.2, Table 3
Voluntary disclosure
Earnings trends:
Why disclose?
Sec 6.1,Table 11
Timing
Sec 6.3
Table 13
Why not disclose?
Sec 6.2, Table 12
Why meet benchmarks? What if miss benchmarks?
Sec 3.4, Table 5
Sec 3.3, Table 4
Why smooth earnings?
Sec 5.1, Table 8
How to meet benchmarks:
Sec 4.1, Table 6
Value sacrifice to meet benchmarks:
Sec 4.2, Table 7
Fig. 1 Flowchart depicting the outline of the paper
Value sacrifice for smooth earnings
Sec 5.2, Table 9
12
Corporate Financial Reporting
Performance measurements
(earnings, cash flows): Sec 3.1,Table 2
Earnings
benchmarks
Sec 3.2, Table 3
Voluntary disclosure
Earnings trends:
Why disclose?
Sec 6.1,Table 11
Timing
Sec 6.3
Table 13
Why not disclose?
Sec 6.2, Table 12
Why meet benchmarks? What if miss benchmarks?
Sec 3.4, Table 5
Sec 3.3, Table 4
Why smooth earnings?
Sec 5.1, Table 8
How to meet benchmarks:
Sec 4.1, Table 6
Value sacrifice to meet benchmarks:
Sec 4.2, Table 7
Fig. 1 Flowchart depicting the outline of the paper
Value sacrifice for smooth earnings
Sec 5.2, Table 9
13
Graham/Harvey/Rajgopal: Corporate Reporting
Motivation
DeGeorge, Patel, Zeckhauser, JB 1999
14
Graham/Harvey/Rajgopal: Corporate Reporting
Earnings benchmarks
0%
20%
40%
60%
80%
100%
Same quarter last year EPS
Analyst consensus EPS forecast
Reporting a profit (i.e. EPS >0)
Previous quarter EPS
Percent of respondents
Responses to the question: “How important are following earnings benchmarks?”
based on a survey of 401 financial executives.
15
Graham/Harvey/Rajgopal: Corporate Reporting
Earnings benchmarks
Conditional: Consensus is relatively more important for
• Firms with more analysts
• Firms that give guidance
• Large firms
• More levered firms
[Table 3]
16
Corporate Financial Reporting
Performance measurements
(earnings, cash flows): Sec 3.1,Table 2
Earnings
benchmarks
Sec 3.2, Table 3
Voluntary disclosure
Earnings trends:
Why disclose?
Sec 6.1,Table 11
Timing
Sec 6.3
Table 13
Why not disclose?
Sec 6.2, Table 12
Why meet benchmarks? What if miss benchmarks?
Sec 3.4, Table 5
Sec 3.3, Table 4
Why smooth earnings?
Sec 5.1, Table 8
How to meet benchmarks:
Sec 4.1, Table 6
Value sacrifice to meet benchmarks:
Sec 4.2, Table 7
Fig. 1 Flowchart depicting the outline of the paper
Value sacrifice for smooth earnings
Sec 5.2, Table 9
17
Graham/Harvey/Rajgopal: Corporate Reporting
Why meet earnings benchmarks?
build credibility with capital market
maintain or increase our stock price
external reputation of management
convey future growth prospects to investors
reduce stock price volatility
assures stakeholders business is stable
employees achieve bonuses
achieve desired credit rating
avoid violating debt-covenants
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100
%
Percent agree or strongly agree
Responses to the statement: “Meeting earnings benchmarks helps …”
based on a survey of 401 financial executives.
18
Graham/Harvey/Rajgopal: Corporate Reporting
Why meet earnings benchmarks?
Stock price motivation
• 86% of CFOs say “builds credibility”
• 80% maintain or increase stock price
19
Graham/Harvey/Rajgopal: Corporate Reporting
Why meet earnings benchmarks?
Stakeholder motivations
• Firms enhance reputation with stakeholders, such as
customers, suppliers, creditors
• Conditional analysis shows this is important for
small, tech, inside dominated, young and not
profitable
20
Graham/Harvey/Rajgopal: Corporate Reporting
Why meet earnings benchmarks?
Employee bonus
• Survey evidence not significant
• Interviews suggest that internal targets more
important for managers (“stretch” and “budget”
greater than consensus)
21
Graham/Harvey/Rajgopal: Corporate Reporting
Why meet earnings benchmarks?
Career concerns
• External reputation very important
• This motivation was prominent in interviews.
Executive labor market important. Failure to deliver
on targets inhibits intra-industry mobility.
22
Graham/Harvey/Rajgopal: Corporate Reporting
Consequences of missing benchmarks
creates uncertainty about our future prospects
outsiders think there are previously unknown problems
have to spend time explaining why we missed
increases scrutiny of all aspects of earnings releases
outsiders might think firm lacks flexibility
increases the possibility of lawsuits
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Responses to the statement: “Failing to meet benchmarks…” based on
a survey of 401 financial executives.
23
Graham/Harvey/Rajgopal: Corporate Reporting
Consequences of missing benchmarks
Uncertainty
• Uncertainty about future prospects is thought to be
priced
24
Graham/Harvey/Rajgopal: Corporate Reporting
Consequences of missing benchmarks
Cockroach problem
• “You have to start with the premise that everyone
manages earnings”
• If you can’t come up with a few cents, there must be
some previously unknown serious problems at the
firm
• “If you see one cockroach, you immediately assume
there are hundreds behind the walls, even though you
have no proof that this is the case”
25
Graham/Harvey/Rajgopal: Corporate Reporting
Consequences of missing benchmarks
Mitigation of negative reaction
• Explain miss is due to specific accounting accrual
• Miss quarterly but confirm annual guidance
• Nonfinancial indicators suggest good future
performance
Other factors
• Conference call becomes negative; investors become
defensive
26
Corporate Financial Reporting
Performance measurements
(earnings, cash flows): Sec 3.1,Table 2
Earnings
benchmarks
Sec 3.2, Table 3
Voluntary disclosure
Earnings trends:
Why disclose?
Sec 6.1,Table 11
Timing
Sec 6.3
Table 13
Why not disclose?
Sec 6.2, Table 12
Why meet benchmarks? What if miss benchmarks?
Sec 3.4, Table 5
Sec 3.3, Table 4
Why smooth earnings?
Sec 5.1, Table 8
How to meet benchmarks:
Sec 4.1, Table 6
Value sacrifice to meet benchmarks:
Sec 4.2, Table 7
Fig. 1 Flowchart depicting the outline of the paper
Value sacrifice for smooth earnings
Sec 5.2, Table 9
27
Graham/Harvey/Rajgopal: Corporate Reporting
Actions taken to
meet
benchmarks
0%
20%
40%
60%
80%
100%
Decrease discretionary spending (e.g. R&D,
advertising, maintenance, etc.)
Delay starting a new project even if this entails a
small sacrifice in value
Book revenues now rather than next quarter (if
justified in either quarter)
Provide incentives for customers to buy more
product this quarter
Draw down on reserves previously set aside
Postpone taking an accounting charge
Sell investments or assets to recognize gains this
quarter
Repurchase common shares
Alter accounting assumptions (e.g. allowances,
pensions etc.)
28
“Near the end of the quarter, it looks like your company might come in below the desired earnings target.
Within what is permitted by GAAP, which of the following choices might your company make?”
Graham/Harvey/Rajgopal: Corporate Reporting
Actions taken to meet benchmarks
Real versus accounting actions
• 80% would reduce discretionary spending, R&D,
maintenance, advertising
• 55.3% would delay starting a new project even if it
entailed a small sacrifice in value
• Not as much support for “accounting actions”
29
Graham/Harvey/Rajgopal: Corporate Reporting
Actions taken to meet benchmarks
Real versus accounting actions
• Little research on real actions
– Dechow and Sloan (JAE 1991); Bartov (TAR 1993);
Bushee (TAR 1998), R&D or asset sales
– Roychowdhury (WP 2003) over produce and sales
discounts to meet targets
30
Graham/Harvey/Rajgopal: Corporate Reporting
Actions taken to meet benchmarks
Real versus accounting actions
• Significantly more likely to say they are taking real
rather than accounting actions
• In contrast, most of the work on “earnings
management” has focused on accruals
31
Graham/Harvey/Rajgopal: Corporate Reporting
Actions taken to meet benchmarks
Why real versus accounting actions?
• Aftermath of Enron-Worldcom along with S-Ox
• Any hint of accounting questions could have
devastating effect on stock prices
• More willing to admit to real actions
• Auditors can’t second guess real actions
32
Graham/Harvey/Rajgopal: Corporate Reporting
Sacrificing long-term value
Hypothetical scenario: Your company’s cost of capital is 12%. Near
the end of the quarter, a new opportunity arises that offers a 16%
internal rate of return and the same risk as the firm. The analyst
consensus EPS estimate is $1.90. What is the probability that your
company will pursue this project in each of the following scenarios?
Actual EPS if you Actual EPS if you
do not pursue the pursue the project
project
The probability that the project will be pursued in this
scenario is …
(check one box per row)
0%
$2.00
$1.90
$1.90
$1.80
$1.80
$1.70
$1.40
$1.30
20%
40%
60%
80%
100%
33
Graham/Harvey/Rajgopal: Corporate Reporting
Sacrificing long-term value
0%
20%
40%
60%
80%
100%
If you take project, you
will exactly hit consensus
earnings
If you take project, you
will miss consensus
earnings by $0.10
If you take project, you
will miss consensus
earnings by $0.20
If you take project, you
will miss consensus
earnings by $0.50
Probability of accepting project
34
Graham/Harvey/Rajgopal: Corporate Reporting
Sacrificing long-term value
EPS if you
do not
pursue
EPS if
you
pursue
$2.00
$1.90
$1.80
$1.40
$1.90
$1.80
$1.70
$1.30
0%
4%
10%
14%
20%
Probability that the project will
be pursued: (Percent of
respondents indicating)
20%
40%
60%
80%
4%
5%
10%
32%
14%
10%
20%
28%
12%
13%
21%
22%
13%
12%
15%
20%
100%
45%
18%
17%
19%
Only 45% would take the project for sure – even if they are projected
to meet consensus
[Table 7]
35
Graham/Harvey/Rajgopal: Corporate Reporting
Sacrificing long-term value
Reminiscent of Brav, Graham, Harvey and Michaely
• Sacrifice positive NPV projects before cutting
dividends
36
Graham/Harvey/Rajgopal: Corporate Reporting
Sacrificing long-term value
4e: Fund externally, rather than cut
3e: Fund externally, rather than cut
4a: Investment decision made 1st
3a: Investment decision made 1st
7h: Good alternative investments
6h: Good alternative investments
7j: M&A strategy
6j: M&A strategy
0%
10%
20%
30%
40%
50%
60%
70%
80%
Percent of CFO's who rate choice as +1 or +2 (on scale of -2 to +2)
Repurchases
Dividends
37
Graham/Harvey/Rajgopal: Corporate Reporting
Other insights on meeting benchmarks
Interviews
• 18/20 interview mentioned trade off of short-run
earnings and long-term optimal decisions
• Investment banks offer products that create
accounting income with negative cash flow
consequences
38
Graham/Harvey/Rajgopal: Corporate Reporting
Other insights on meeting benchmarks
Guidance
• Goal of guidance is to meet or exceed consensus
every quarter
• Analysts complicit in game of always meeting or
exceeding
• Large positive surprises lead to “ratchet-up effect”
• Asymmetric
39
Graham/Harvey/Rajgopal: Corporate Reporting
Other insights on meeting benchmarks
Break out of the game
• Why not declare that you will not play the earnings
management game?
40
Corporate Financial Reporting
Performance measurements
(earnings, cash flows): Sec 3.1,Table 2
Earnings
benchmarks
Sec 3.2, Table 3
Voluntary disclosure
Earnings trends:
Why disclose?
Sec 6.1,Table 11
Timing
Sec 6.3
Table 13
Why not disclose?
Sec 6.2, Table 12
Why meet benchmarks? What if miss benchmarks?
Sec 3.4, Table 5
Sec 3.3, Table 4
Why smooth earnings?
Sec 5.1, Table 8
How to meet benchmarks:
Sec 4.1, Table 6
Value sacrifice to meet benchmarks:
Sec 4.2, Table 7
Fig. 1 Flowchart depicting the outline of the paper
Value sacrifice for smooth earnings
Sec 5.2, Table 9
41
Graham/Harvey/Rajgopal: Corporate Reporting
Smoothing
96.9% and 20/20 interviews prefer smooth earnings
over more volatile holding cash flows constant
42
Graham/Harvey/Rajgopal: Corporate Reporting
Smoothing
0%
20%
40%
60%
80%
100%
Is perceived as less risky by investors
Makes it easier for analysts/investors to predict
future earnings
Assures customers/suppliers that business is stable
Reduces the return that investors demand (i.e.
smaller risk premium)
Promotes a reputation for transparent and accurate
reporting
Conveys higher future growth prospects
Achieves or preserves a desired credit rating
Clarifies true economic performance
Increases bonus payments
Responses to the question: “Do the following factors contribute to your
company preferring a smooth earnings path?”
43
Graham/Harvey/Rajgopal: Corporate Reporting
Smoothing
Reasons
• Lowers “risk”; increased predictability; lower “risk”
premium
• Clear from survey and interviews that CFOs believe
that this risk is priced
• Possible link to literature on: estimation error,
disagreement in asset pricing, information risk
premium, and behavioral literature on risk versus
uncertainty
44
Graham/Harvey/Rajgopal: Corporate Reporting
Sacrificing value for smoothing
0%
20%
40%
60%
80%
100%
None
Small sacrifice
Moderate sacrifice
Large sacrifice
Responses to the question: “How large a sacrifice in value would your firm
make to avoid a bumpy earnings path?”
45
Graham/Harvey/Rajgopal: Corporate Reporting
Other insights on smoothing
Interviews
• Volatile earnings will create trading incentives for
speculators, hedge funds and legal vultures
• Volatile earnings mean that you will have a number of
misses – which CFOs want to avoid
Smoothing example
46
Graham/Harvey/Rajgopal: Corporate Reporting
Marginal investor
2%
2%
7%
Institutions
Analysts
Individuals
36%
53%
Rating Agencies
Hedge Funds
Responses to the statement: “Rank the two most important groups in
terms of setting the stock price for your company”
47
Graham/Harvey/Rajgopal: Corporate Reporting
Marginal investor
Price setters
• Institutional investors
• Analysts have important short-term impact
• Retail investors important because they are potential
customers and are less likely to flip stock
48
Graham/Harvey/Rajgopal: Corporate Reporting
Marginal investor
Critique of analysts, institutions
• Young, do not have sense of history
• Contagion: bandwagon effect important given relative
performance measurement
• Quantitative hedge funds issue sell signal if you miss
–irrespective of fundamental information
CFOs believe idiosyncratic risk is priced
49
Corporate Financial Reporting
Performance measurements
(earnings, cash flows): Sec 3.1,Table 2
Earnings
benchmarks
Sec 3.2, Table 3
Voluntary disclosure
Earnings trends:
Why disclose?
Sec 6.1,Table 11
Timing
Sec 6.3
Table 13
Why not disclose?
Sec 6.2, Table 12
Why meet benchmarks? What if miss benchmarks?
Sec 3.4, Table 5
Sec 3.3, Table 4
Why smooth earnings?
Sec 5.1, Table 8
How to meet benchmarks:
Sec 4.1, Table 6
Value sacrifice to meet benchmarks:
Sec 4.2, Table 7
Fig. 1 Flowchart depicting the outline of the paper
Value sacrifice for smooth earnings
Sec 5.2, Table 9
50
Graham/Harvey/Rajgopal: Corporate Reporting
Voluntary disclosure
Types
• Conference calls, meetings, press releases, and
disclosure of more than mandated information in
regulatory filings
• Healy and Palepu (2001) say that motivations for
voluntary disclosure “important unresolved question
for future research”
51
Graham/Harvey/Rajgopal: Corporate Reporting
Voluntary disclosure
Drivers
• Information asymmetry
• Increased analyst coverage
• Corporate control contest
• Stock compensation
• Management talent
• Limitations of mandatory disclosure
52
Graham/Harvey/Rajgopal: Corporate Reporting
Voluntary disclosure
Contraints
• Litigation risk
• Proprietary costs
• Political costs
• Agency costs
• Setting a precedent that may be hard to maintain
53
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
0%
20%
40%
60%
80%
100%
promotes a reputation for transparent/accurate reporting
reduces the “information risk” that investors assign to
our stock
provides important information to investors that is not
included in mandatory financial disclosures
increases the predictability of our company’s future
prospects
attracts more financial analysts to follow our stock
corrects an under-valued stock price
increases the overall liquidity of our stock
increases our P/E ratio
reveals to outsiders the skill level of our managers
reduces our cost of capital
reduces the risk premium employees demand for
holding stock granted as compensation
Survey responses to the question: Do these statements describe your
company's motives for voluntarily communicating financial information?
54
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Information asymmetry: Information risk
• Diamond Verrecchia (1991) voluntary disclosure
reduces asymmetry between informed and
uninformed, increases liquidity.
– 81.9% agree – only 4.3% disagree
– Related 56.2% agree that predictability of company’s future
prospects is enhanced
55
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Information asymmetry: Information risk
• Interviews distinguish between “information risk”
and “inherent risk”
• Believe that both command a risk premium
• Releasing bad news quickly can be beneficial in
reducing information risk
56
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Information asymmetry: Reputation
• 92.1% agree with reputational benefit for transparent
reporting (scores the highest)
• Interviews:
– Correct investors misperceptions
– Create an environment of trust so strategic actions more
easily taken in the future
– Trust may be important in gaining access to future capital
57
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Information asymmetry: Cost of capital
• While only 39.3% point to cost of capital, the
information risk is linked to cost of capital
• P/E lift 42% might be similar to the cost of capital
• Interviews:
– A number mentioned “reducing analysts disagreement” and
linked that to cost of capital
58
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Information asymmetry: Liquidity
• Motivation especially for small firms
59
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Increased analyst coverage:
• Bhushan (1989a,b) and Lang and Lundholm (1996)
• 50.8% agree
• More agreement with small and insider dominated
firms
60
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Stock price motivation:
• 48.4% use disclosure to try to correct undervalued
stock
61
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Stock compensation:
• Managers want to reduce contracting costs with
employees where there is information asymmetry,
otherwise employees will demand a risk premium
• No support, half disagree
62
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Management talent signaling:
• Trueman (1986)
• More support for small firms plus other questions
suggest that this is important
63
Graham/Harvey/Rajgopal: Corporate Reporting
Motivations for voluntary disclosure
Limitations of mandatory disclosures (new):
• 72.1% say that voluntary corrects gaps in mandatory
• Interviews:
– Some mandatory “confuse rather than enlighten”
– “Some of our own footnotes related to off-balance sheet
items and securitizations are so complex, even I don’t
understand them.”
– Quarterly mandatory disclosures lack timeliness
– Mandatory ignores intangibles
64
Graham/Harvey/Rajgopal: Corporate Reporting
Constraints on voluntary disclosure
0%
20%
40%
60%
80%
100%
avoid setting a disclosure precedent that may be
difficult to continue
avoid giving away “company secrets” or otherwise
harming our competitive position
avoid possible lawsuits if future results don’t match
forward-looking disclosures
avoid potential follow-up questions about
unimportant items
avoid attracting unwanted scrutiny by regulators
avoid attracting unwanted scrutiny by stockholders
and bondholders
Survey responses to the question: Limiting voluntary communication of financial
information helps…
65
Graham/Harvey/Rajgopal: Corporate Reporting
Constraints on voluntary disclosure
Precedent (new)
• The most popular response with 69.6% agreeing
• Most important for insider dominated firms
• Start a practice that you might want to abandon later
66
Graham/Harvey/Rajgopal: Corporate Reporting
Constraints on voluntary disclosure
Litigation costs
• Threat of litigation makes managers disclose bad
news quickly
• 46.4% agree; especially important for young and tech
67
Graham/Harvey/Rajgopal: Corporate Reporting
Constraints on voluntary disclosure
Proprietary costs
• Might jeopardize firm’s competitive position
• 58.8% agree
• More agreement with small firms and those with few
analysts
68
Graham/Harvey/Rajgopal: Corporate Reporting
Constraints on voluntary disclosure
Agency costs
• We know that career concerns and external
reputation important for meeting benchmarks
• Information may be limited to reduce the chance of
undue focus by stakeholders
• Not much support – for this agency cost angle
69
Graham/Harvey/Rajgopal: Corporate Reporting
Constraints on voluntary disclosure
Political costs
• Disclosure may be limited to avoid unwanted
attention of regulators
• No support on average – but this question, in
particular, is difficult to interpret
70
Graham/Harvey/Rajgopal: Corporate Reporting
Good news versus bad news
Bad news faster
No difference
Good news faster
Survey responses to the question: Based on your company's experience,
is good news or bad news released to the public faster?
71
Graham/Harvey/Rajgopal: Corporate Reporting
Good news versus bad news
0%
20%
40%
60%
80%
100%
Disclosing bad news faster enhances our reputation
for transparent and accurate reporting
Disclosing bad news faster reduces our risk of
potential lawsuits
Good news is released faster because bad news
takes longer to analyze and interpret
Good news is released faster because we try to
package bad news with other disclosures which
can result in a coordination delay
Survey responses to the question: Do the following statements describe
your company's motives related to the timing of voluntary disclosures?
72
Graham/Harvey/Rajgopal: Corporate Reporting
Conclusions
• Consensus earnings factors into decisions
• Strong desire to meet benchmarks – cockroach
problem
• It is routine to sacrifice long-term value to meet these
benchmarks
• Meeting benchmarks is important both for the firm’s
stock price and managers reputation and mobility
• Agents optimizing over short-term horizon
73
Graham/Harvey/Rajgopal: Corporate Reporting
Conclusions
• Having predictable smooth earnings is thought to
both reduce the cost of capital and enhance manager
reputation
• Voluntary disclosure is an important tool in
manager’s arsenal
• Disclosure can potentially reduce information risk
and enhance a manager’s reputation
74
Graham/Harvey/Rajgopal: Corporate Reporting
Future research
Last survey instrument!
• We are thinking of administering the identical survey
before it is published to non-management members of
Boards of Directors.
Also…
• “Detection of Financial Earnings Management”
• “Detection of Real Earnings Management”
We have the tickers for 107 firms many of which admit
to both financial and real earnings management 75