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Review of Accounting Studies

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10-01-2020

Opportunity knocks but once: delayed disclosure of financial items in earnings announcements and neglect of earnings news

Authors: Yifan Li, Alexander Nekrasov, Siew Hong Teoh

Published in: Review of Accounting Studies | Issue 1/2020

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Abstract

We define a delayed disclosure ratio (DD) as the fraction of 10-Q financial statement items that are withheld at the earlier quarterly earnings announcement. We find that higher DD firms have a greater delay in investor and analyst response to earnings surprises: (i) the fraction of total market reaction to quarterly earnings news realized around the earnings announcement (after the 10-Q filing) is smaller (greater), and (ii) analysts are more likely to defer issuing forecasts from immediately after the earnings announcement to after the 10-Q filing. Consistent with our limited attention model predictions, the response catch-up associated with DD is incomplete, even after the delayed items are fully disclosed at the 10-Q filing date, and persists until the next earnings announcement date. The return reaction to earnings news over the entire quarter does not vary with DD, so differences in earnings informativeness do not explain the DD effect. Our findings suggest that, for limited attention effects to be mitigated, the timing of disclosures must be coincident with the focal periods—at earnings announcement dates—when investors and analysts are paying the most attention.

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In our sample, market reactions and analyst revisions at the earnings announcement are almost twice as large as at the filing date. Specifically, the mean absolute market-adjusted abnormal return is 6.54% around earnings announcements and 3.77% around 10-Q filings. The mean absolute analyst earnings forecast revision is 0.50% around earnings announcements and 0.32% around 10-Q filings (untabulated). The weak investor reaction at filing dates is consistent with the work of Easton and Zmijewski (1993), who examine a pre-EDGAR sample. Griffin (2003) finds a significant reaction around 10-Q/K for a post-EDGAR sample. However, Li and Ramesh (2009) report that the significant reaction is driven by 10-Q/K filings that coincide with earnings releases.

The importance of the timing of financial information dissemination was also raised in an SEC Concept Release in April 2016. The Commission has raised questions about the costs and benefits of quarterly reporting, including: “Should we revise or eliminate our rules requiring quarterly reporting?” The SEC mandated quarterly reports in 1970. However, even prior to the SEC’s adopting the quarterly Form 10-Q, more than 70% of public companies produced quarterly reports (SEC Concept Release, April 2016).

Studies suggest that more detailed financial statement item disclosure represents higher disclosure quality (Chen et al. 2015; Francis et al. 2002; Collins et al. 2009) and enhances the credibility of earnings by limiting managers’ degrees of freedom to manage earnings (Hirst et al. 2007; D’Souza et al. 2010). While disclosure quality or credibility shifts the weight that fully attentive rational investors put on earnings news, these factors do not imply that delayed disclosure induces a systematic delayed reaction, or PEAD, unless inattention is also present.

For example, Chen et al. (2002) find that companies disclose balance sheets in earnings press releases when current earnings are likely to be less informative or when future earnings are more uncertain.

We focus on quarterly earnings announcements to avoid the issue of audit completeness at the announcements of annual earnings (Schroeder 2016; Marshall et al. 2018). In an additional analysis, we examine the effect of delayed disclosure in the annual earnings announcements.

The samples in Levi (2008) and Louis et al. (2008) are also smaller: six quarters from 2001 to 2002 in the former, and four years from 1999 to 2002 in the latter. Because we are focused on the potential mispricing of general financial statement items, we are also able to sidestep the thorny difficulties of estimating discretionary accruals, a common problem for accrual anomaly studies.

Chen et al. (2002) show that financial statement disclosures can indicate lower informativeness of earnings, which suggests a lower ERC. Arif et al. (2017) find that concurrent disclosure of annual earnings news and the annual financial statement filings leads to information overload, lower response to earnings news, and a greater PEAD.

It does not matter for the analysis whether the attentiveness of any given investor at a given date is random or is the outcome of a deterministic process. What matters is the fraction of investors who are attentive at each date. Inattentive investors do not know there is a signal that they are ignoring, i.e., they do not know that they are inattentive.

The zero net supply assumption implies a zero net market risk premium, which eliminates the nuisance risk premium term from the pricing equation. Investor risk aversion still plays a role by determining relative weights by attentive and inattentive investors in the pricing equation.

Risk aversion prevents the attentive investors at the filing date from being able to fully arbitrage away the mispricing induced by the inattentive investors at the earlier earnings announcement date.

This prediction is consistent with the Francis et al. (2007) finding that information uncertainty, proxied by the noise in how accruals map into cash flows, positively relates to PEAD.

Huang et al. (2018) study the effects of presentation format, whereas our study examines the timing of the disclosure of the detailed financial statement items.

We include the return over the next earnings announcement window since research shows that much of the delayed investor reaction is concentrated in that period (Bernard and Thomas 1990).

Past empirical studies find that investor attention is influenced by, among other factors, the coverage of the announcement in prominent media outlets (Klibanoff et al. 1998), the day of the week (DellaVigna and Pollet 2009), the number of same day other firm earnings announcements (Hirshleifer et al. 2009), the dissemination of the announcement on social media (Blankespoor et al. 2014), and the salience of the earnings announcement headline (Huang et al. 2018). Additionally, the Wall Street Journal publishes anticipated dates when earnings will be released but not when financial statements will be filed with the SEC, so investors are more likely to be attentive on earnings announcement dates than on filing dates. You and Zhang (2011) make a similar argument that investors pay greater attention to earnings announcements than 10-K filings. In the model, we assume that an information signal, in the form of financial statement items, is more likely to be processed by investors when it is disseminated more prominently or when investor attention is higher, i.e., in the earnings press release.

To check the accuracy of the Prelim data, we select a random sample of 50 firms with available observations before and after 1999. We then manually identify financial statement items disclosed in earnings press releases and compare the delayed disclosure ratio based on the manually collected data and the ratio based on the Prelim data. The Spearman correlation between the two ratios exceeds 0.90 both before and after 1999, suggesting that the delayed disclosure measure based on the Prelim data is reasonably accurate.

Delayed disclosure is measured by comparing the disclosure in the earnings press release with the disclosure in the same quarter 10-Q filing. As a robustness check, we also calculate DD by comparing items disclosed in the earnings press release with items reported in the 10-Q filing for the same quarter last year. The correlation between this DD and our main measure is 0.9982. All our results are qualitatively and quantitatively similar when using this alternative DD measure (untabulated).

Nevertheless, most of the results hold when using dollar value–weighted DD. Higher dollar value–weighted DD is negatively (positively) associated with the fraction of analyst forecasts issued immediately after the earnings announcement (after the 10-Q filing) and the market reaction to earnings news immediately around the earnings announcement (after the 10-Q filing) (untabulated).

The average percentage of delayed income statement, balance sheet, and cash flow statement items is 24.7%, 51.5%, and 86.4%, respectively (untabulated). The descriptive statistics are comparable with those of D’Souza et al. (2010).

Together, firm size, institutional ownership, and analyst following explain 12.1% of the variation in DD based on regression R² (untabulated).

While Figure 2 also suggests that there is a positive association between DD and %FORECASTS_[EA + 2, Filing Date − 2], the results in the next section show that this association is negative and insignificant in the multivariate analysis.

We add further robustness checks. In addition to year fixed effects, we add a control for a time trend in the immediate and delayed response to earnings news by including an interaction between RSUE and a time trend variable. The time trend variable is the natural logarithm of (year – 1988), and year is the observation’s fiscal year from 1989 to 2013 (Collins et al. 2009). The untabulated results are consistent with those in Tables 3 and 4. As another robustness check, we use earnings surprise based on a seasonal random walk instead of analyst forecasts, and find similar results.

The notes to Figure 3 provide details on how the graph is constructed.

We conduct two sets of robustness tests. First, we add earnings announcement lag, special items indicator, loss indicator, indicator of negative earnings surprise, and their interactions with earnings surprise as additional controls to the main regressions in Tables 3–6. The results of the key independent variables—RSUE*DD in Tables 3–4 and Table 6 (Panel A) and DD in Table 5 and Table 6 (Panels B and C)—are robust. Next, regarding the residual DD variable in the 2SLS regressions in Table 7, we also add the additional controls in the second stage regression. The results for the key independent variables relating to residual DD remain robust. Since residual DD is orthogonal to the control variables used in the first stage, the two-stage approach avoids the need to include, in the second stage, a large number of interactions, RSUE_jt*Control_jt, that are highly correlated with each other, and thus increases the reliability of the empirical inferences.

Schroeder (2016) finds that completed audits at the earnings announcement date enhance the information content of additional financial statement items at the annual earnings announcement. Marshall et al. (2018) find that the market places more weight on good annual earnings news announced after audit completion. Our study differs from these studies in that we study quarterly earnings that do not have audit-related issues. In addition, our limited attention approach affords predictions for post-event investor reactions, whereas the credibility effect from completed audits in these studies predicts only earnings announcement period reactions and not post-event reactions.

The lower magnitude of PEAD after annual announcements is likely to result in a lower test power. We find that even though the magnitude of the coefficient on RSUE*DD might suggest an economically meaningful effect when compared to the average PEAD after annual announcements, the coefficient is not statistically significant.

Holzman et al. find that delayed disclosure of operating income items increases PEAD, whereas delayed disclosure of nonoperating income items decreases PEAD, so the net PEAD effect from delayed disclosure of items in the overall income statement is weak, which is consistent with our finding.

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Title: Opportunity knocks but once: delayed disclosure of financial items in earnings announcements and neglect of earnings news
Authors: Yifan Li
Alexander Nekrasov
Siew Hong Teoh
Publication date: 10-01-2020
Publisher: Springer US
Published in: Review of Accounting Studies / Issue 1/2020
Print ISSN: 1380-6653
Electronic ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-019-09519-7

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