The Incremental Value Relevance of Geographic Segment Disclosures: Canadian Evidence

Roger Graham, Oregon State University Cameron Morrill, University of Manitoba Janet Morrill, University of Manitoba May 2005

Presentation Agenda

1. Introduction 2. Literature o Segmented Disclosures o Quebec environment and Political Risk 3. Research model 4. Data and Results 5. Conclusions

Segmented Disclosures

• Objective of segmented disclosures is to help users: – Better understand the enterprise’s performance – Better assess future cash flows – Make more informed judgments about the enterprise as a whole • “reportable segments” can be either geographic or by line of business

Changes to Canadian Section 1701 (similar to SFAS 131)

• Reporting consistent with internal reporting • Less information by geographic segment • Geographic segment required for country of domicile and foreign countries combined, and on a country-by country basis if material • •

Is information by geographic segment important?

Can there be important information at a level other than by country?

Usefulness of geographic segment disclosure (old rules)

• Weak evidence of market reaction to unexpected profits by geographic segment Boatsman et al, 1993 • Over long windows, link between security returns and geographic segment earnings differs by segment Thomas, 2000 • No evidence of geographic usefulness under new rules

Usefulness of LOB disclosure

• Survey respondents perceive segmented information useful Baldwin, 1984; Berger et al, 2003; Lobo et al 1998 • Link between market values and financial information is stronger when using segmented information instead of aggregated information Tse, 1989; Givoly et al, 1999 • Incremental content of l.o.b. is small but significant. Significance increases with differential profit and growth opportunities Chen and Zhang, 2003

Our approach

To test whether information on extent of operations in Quebec (from a non-financial-statement source) is value relevant Implications: 1. Market is efficient with respect to other public information 2. Geographic segment information is value relevant 3. Information at a sub-national level can be relevant.

Quebec’s Business Environment

• Political Uncertainty – Possibility of secession – Possible negative consequences • Bill 101 • Quebec Civil Code • Restrictions on Corporate Takeovers

Potential economic consequences of Quebec sovereignty: The market’s assessment • Firms moving out of Quebec earn positive abnormal returns (Tirtiroglu, Bhabra and Lel, 2004) • Quebec-headquartered firms trade at a discount (Graham, Morrill and Morrill, 2005) • Quebec provincial bond yields increase as support for Quebec sovereignty increases (Johnson and McIlwraith, 1998)

Market – book model (GMM 2005)

Basic model: MVE it+2 MVE it+2 =  t +  t *Q it = ß 1 BVE + ß 1 BVE it it + ß 2 E it + e + ß 2 Q*BVE it + ß 3 E it + ß 4 Q*E MVE = market value of equity it + e it Q = 1 for Quebec firm; 0 for non-Quebec BVE = book value of equity E = earnings from continuing operations  = controls for size, growth, leverage,year Results: ß 1 , ß 3 > 0; ß 2 , ß 4 < 0

Our market – book model

MVE it+2 =  t + + ß 4 Q*E it  t *Q it + ß 1 BVE it + ß 5 PCT it + ß 6 + ß 2 Q*BVE + ß 3 E it Q*PCT it + ß 7 PCT it *BVE it + ß 8 PCT it *E it + e it MVE = market value of equity Q = 1 for Quebec firm; 0 for non-Quebec BVE = book value of equity E = earnings from continuing operations PCT = extent of firm operations in Quebec  = controls for size, growth, leverage,year

Data

• Firms with accounting and market data available in Compustat TSE data file • Firms with Quebec segment information (employees, sales, assets) in

Les Affaires

• Deleted firms with – Insufficient data – Negative book values – Extreme values (top and bottom 2%) of earnings and sales growth

Descriptive statistics

(* = QC vs. non-QC different, p<.05) QC employees* QC sales* QC assets* EPS BV per share MV per share* QC firms (82) N Mean Non-QC firms (51) N Mean 590 211 250 54.5% 58.3% 67.4% 418 156 135 27.2% 35.2% 28.0% 590 590 588 $0.80

$9.17

$11.64

418 418 417 $0.77

$10.27

$16.73

Market Value Regression Results

BVE = book value of equity; E = earnings; Q = Quebec dummy; PCT = % employees in QC.

*(**) significant at p < 0.05 (p<0.01) Ind. variable BVE E Q*BVE Q*E PCT*BVE PCT*E Adj. R 2 Exp.

+ + Model 1 1.44** 2.02** -0.20* -0.06

0.85

Model 2 1.30** 1.75** -0.36* 0.95* 0.85

Model 3 1.50** 1.66** 0.07

-1.05** -0.99** 3.16** 0.86

Tests of incremental explanatory power

Effect of adding: F (df numerator, df denominator) [probability] PCT variables to location-only model Location variables to PCT only model F (6,907) = 4.58 [ p<0.001 ] F (5,907) = 7.77 [ p<0.001 ]

Conclusion

• Firms located in Quebec have lower market multiples on book value an earnings leading to lower firm values (we knew that already) • Segment disclosure, even voluntarily disclosed and unaudited, seems to be value relevant in addition to location of firm headquarters

Disclosure Implications

Expanded geographical disclosures could provide relevant information • Bringing geographic information into realm of financial statements allows it to be subjected to audit • Re-visit decision to provide geographic information by country only – Allowing discretion or specifying conditions could increase relevance – Danger is threat to reliability from “strategic aggregation or disaggregation”

Paper is available at: http://www.umanitoba.ca/asper/faculty/cam.morrill/