Abstract
Using a comprehensive sample of non-earnings 8-K filings from 2005 to 2013, we examine whether firms strategically report mandatory and voluntary news. In particular, we examine whether firms report negative news when investor attention is low and whether they bundle positive and negative news. Our findings support the notion that managers believe in the existence of investor inattention and strategically report negative news after trading hours. These results particularly apply to public firms, where equity market pressures provide stronger incentives to mitigate market reaction to news by exploiting investor inattention. Further analysis of the market reaction to strategic disclosure uncovers no evidence of investor inattention, consistent with market efficiency. We also observe that public firms are more likely to strategically disclose through news bundling and that the likelihood of this increases with the likelihood of strategic disclosure through timing.
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Notes
Examples of reportable items include entry into a material agreement or its termination, bankruptcy or receivership, and material impairments, to name a few. See Sect. 2 for more detail.
Firms could try to strategically bundle mandatory items. However, the reporting requirements for mandatory items afford less flexibility (see Sect. 2). Hence we focus on the bundling of mandatory and voluntary items.
One could argue that reporting ATH is consistent with the SEC’s effort to provide investors equal access to the information. While plausible, note that the SEC’s effort applies to all information, positive or negative. Our finding that negative news is more likely to be reported ATH is therefore more consistent with strategic reporting (i.e., an attempt to exploit investor inattention).
DeHaan et al. (2015) show that investor attention is indeed low ATH, on Fridays, and on busy days. Specifically, they provide evidence that, when earnings are released ATH or on busy reporting days, there are fewer news articles, EDGAR downloads, Google searches and analysts update their forecasts more slowly.
Although Gennotte and Trueman (1996) use earnings announcements in the discussion of their model, the model is generalizable to any mandatory public announcements (i.e., to non-earnings news as well).
Managers aim to maximize post-announcement share price for reasons related to compensation, job security, and litigation. Specifically, Jayaraman and Milbourn (2012) find that, as stock liquidity increases, the proportion of equity-based (cash) compensation in total compensation increases (decreases). Hence it is likely that managers of public firms receive a greater portion of their compensation in equity-based instruments, leading to greater compensation sensitivity to stock price. Defond and Hung (2004) and others document a link between CEO turnover and poor stock returns. Also, the likelihood of litigation is affected by stock reaction to negative events (see for example, Kim and Skinner 2012).
One could argue that managers have no reason to disclose negative voluntary news. However, voluntary news in the context of 8-K filings are material events that are eventually reported in the subsequent periodic 10-Q/K. Given that the news would eventually be released, the firm bears no real cost in disclosing negative voluntary news early. This is similar to management forecasts, which are used as the main proxy for voluntary disclosure. Once managers decide to issue forecasts, they typically do so regularly whether the news is positive or negative. In addition, the literature indicates that less timely disclosure increases firms’ litigation consequences (e.g., Skinner 1994; Kasznik and Lev 1995; Skinner 1997, Baginski et al. 2002). For example, Skinner (1994) argues that U.S. securities laws provide incentives for managers to disclose negative news voluntarily. This is because announcements of negative earnings surprises increase the likelihood of shareholder litigation. Early disclosures both reduce the plaintiffs’ ability to claim that managers failed to release material information promptly and limit the size of the plaintiff class by reducing the period of nondisclosure.
The SEC issued Release No. 34-49424, additional Form 8-K disclosure requirements and acceleration of filing date, in March 2004, and it became effective on August 23, 2004. The rule significantly increased the number of events to be reported in the 8-K report and shortened the period required to disclose these events to no more than four business days after the event.
Both the Exchange Act and Securities Act require a company to register its securities with the SEC if those are held by 500 (and in some situations, 300) or more persons and the company’s total assets exceed $10 million. Our definition of public firms is similar to that of Givoly et al. (2010).
Regular stock market hours are 9:30 a.m.–4 p.m. Eastern Time. About 88 % of the ATH cases were disclosed between 4 p.m. and 6 p.m. About 10 % of the observations were filed before market opens (BMO), and we treat them as filed during trading hours. Footnote 17 describes sensitivity analysis related to BMO disclosure.
Throughout our analysis, we assume that the news is disseminated to the market via 8-K report first. We expand on this issue in Sect. 4.5.1.
As a sensitivity analysis, we examine the mean market reaction by deciles formed on the basis of the news score. Untabulated results show that the mean market reaction generally increases with the news deciles, with the lowest (highest) mean return in the bottom (top) news deciles.
Kothari et al. (2009) show that litigation risk, distress risk, and information asymmetry moderate the decision of firms to delay the disclosure of negative news. Untabulated results indicate that these variables are not related to the decision to disclose when investor attention is low, and controlling for these variables does not affect the inferences.
The specification is based on negative news indicator in the equity return regressions because we also control for the absolute value of CAR. If we instead use equity returns as the proxy for news and omit absolute CAR from the regression, we find that the coefficient on the news variable is negative and significant, consistent with strategic reporting of negative news.
We do not control for governance in the reported results because data on the GIM and entrenchment variables is limited, resulting in a significantly smaller sample.
We also examine whether filing before market opens (BMO) is associated with strategic reporting of negative news. We find that there is no association between the type of news and BMO reporting; the likelihood of negative news reported BMO is similar to that of positive news.
We examine whether the results are sensitive to the measurement of the news variable. Specifically, we re-estimate the regressions defining as negative news all forms containing a priori negative news (see Sect. 4.1 for detail). In an additional analysis, we define negative news as one if the news score is in the lowest quartile. In both analyses, we observe that the likelihood of strategic reporting of negative news is higher for public firms than nonpublic ones.
An alternative strategy is analogous to the “big bath” strategy—reporting all negative news together or, conversely, bundling positive voluntary and mandatory news. We choose to focus on the more plausible motivation for strategic reporting (that is, mitigating the reaction to negative events) and thus concentrate on cases where the firms report both voluntary and mandatory items but with conflicting signs.
We construct this cumulative measure, rather than an annual measure, because the filing of 8-K reports varies considerably over time, and the average number of 8-K reports filed annually is fairly small, with an even lower number of forms with negative news.
Since the regressions are estimated at the firm-year level (as opposed to firm-form level in previous regressions), we do not control for item fixed effect or the economic impact of the form.
One potential concern with our measure of strategic reporting is that it may be noisy in the early years of the data because of the smaller number of observations. To address this issue we measure strategic reporting using all of the data. While this measure is less noisy, the analysis involves look-ahead bias. Nevertheless, the results are similar to those reported—the likelihood of news bundling increases with strategic reporting through disclosure timing.
To ensure that the analysis is not contaminated by the presence of additional items reported in the form, we include only single-item forms. In a sensitivity analysis, we remove this restriction and examine all forms including multi-item filings. None of the inferences change.
For information on EDGAR FTP access and use of EDGAR Index files, see https://www.sec.gov/edgar/searchedgar/ftpusers.htm.
Complete lists of positive and negative words can be downloaded from Bill McDonald’s website: http://www3.nd.edu/~mcdonald/Word_Lists.html.
For a comprehensive review of papers using the LM measure and related literature, see Loughran and McDonald (2015).
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Acknowledgments
A previous version of this paper was titled, “The Opportunistic Reporting of Material Events and the Apparent Misconception of Investors’ Reaction.” We thank seminar participants at INSEAD, Tel-Aviv University, Hebrew University, UC Davis, Baruch College, Hofstra University, Fordham University, Claremont McKenna College, and the 2013 SMU accounting symposium participants and discussant for helpful comments and suggestions. Financial support from the INSEAD R&D fund is gratefully acknowledged.
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Appendices
Appendix 1: Form 8-K items—number and description
Item description | Item number |
|---|---|
Entry into a Material Definitive Agreement | 1.01 |
Termination of a Material Definitive Agreement | 1.02 |
Bankruptcy or Receivership | 1.03 |
Mine safety—reporting of shutdowns and patterns of violations | 1.04 |
Completion of acquisition or disposition of assets | 2.01 |
Results of operations and financial condition | 2.02 |
Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant | 2.03 |
Triggering Events That Accelerate or Increase a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement | 2.04 |
Costs associated with exit or disposal activities | 2.05 |
Material Impairments | 2.06 |
Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing | 3.01 |
Unregistered sales of equity securities | 3.02 |
Material modification to rights of security holders | 3.03 |
Changes in Registrant’s Certifying Accountant | 4.01 |
Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review | 4.02 |
Changes in control of registrant | 5.01 |
Departure of directors or certain officers; election of directors; appointment of certain officers; compensatory arrangements of certain officers | 5.02 |
Amendments to articles of incorporation or bylaws; change in fiscal year | 5.03 |
Temporary suspension of trading under registrant’s employee benefit plans | 5.04 |
Amendment to registrant’s code of ethics, or waiver of a provision of the code of ethics | 5.05 |
Change in shell company status | 5.06 |
Submission of matters to a vote of security holders | 5.07 |
Shareholder director nominations | 5.08 |
Asset-backed securities | 6.01–6.05 |
Regulation FD disclosure | 7.01 |
Other events | 8.01 |
Financial statements and exhibits | 9.01 |
Appendix 2
2.1 Form 8-K data
We use the FTP access and Index files to download the entire universe of 8-K filings from the SEC’s Electronic Data Gathering, Analysis and Retrieval online system (EDGAR) filed between the years 2005 and 2013.Footnote 24 We machine read the 8-K forms to identify and extract the information in the form. Edgar filings contain in the header section of the form a submission date-and-time stamp (YYYYMMDDHHMMSS), submission type (form type, e.g., 8-K), Filed As of Date (filing date), and several company identifiers including company name, central index key (CIK), SIC code, IRS number, and address. We further identify the beginning and end of all reported items in the body of the form based on their captions and extract their text. Finally, we count total words as well as financial positive and financial negative words in each item text, based on the Loughran and McDonald (2011) word lists described below.
2.2 Textual analysis
Textual analysis has been widely used in the literature to identify and classify the sentiment of text. In a recent paper, Kearney and Liu (2014) provide a detailed survey of the textual sentiment literature and describe the information sources analyzed and content analysis methods. Textual analysis has been used to examine the tone of press releases (Davis et al. 2012), analysts reports (De Franco et al. 2015), management discussion and analysis in 10-Ks (Feldman et al. 2010), and annual reports (Lehavy et al. 2011), to name a few.
A growing recent literature uses the Loughran and McDonald (2011) word lists, a modified version of the Harvard dictionaries, to identify the tone of the news. Loughran and McDonald created a list of financial-negative and financial-positive words based on a comprehensive sample of 50,115 firm-year 10-Ks filed between 1994 and 2008. In particular, they map all the words in their 10-K sample, and they examine words occurring in at least 5 % of the documents to determine their most likely usage and classification in financial documents. They include inflections and take into account negation when constructing their final word lists. They produce a list of 2337 words in their financial-negative category (e.g., loss, impairment, decline) and 353 words in their financial-positive category (e.g., achieve, attain, efficient, improve, profitable).Footnote 25 Some papers focus on the negative word lists only (e.g., Chen et al. 2014) or on both positive and negative terms (e.g., Garcia 2013), while others (e.g., Hanley and Hoberg 2010), including this manuscript, use “net sentiment,” defined as the difference between the proportion of negative and positive words based on the Loughran and McDonald word lists.Footnote 26 Specifically, for each of the 8-K forms we compute Form News as the difference between the total number of positive and negative financial words and then scale the difference by the total number of words. We compute voluntary and mandatory news similarly. Voluntary news is computed as the difference between the number of positive and negative financial words in Item 8.01 scaled by the total number of words in the item. Mandatory news is computed as the difference between the number of positive and negative financial words in all other items scaled by the total number of words in the corresponding items.
Appendix 3
3.1 Variable definition
Three-day cumulative abnormal returns—Abnormal returns are computed based on Carhart (1997) four-factor model. The CAR is centered on the first day investors could trade on the information. Specifically, if the news is disclosed non-ATH (ATH), we use CAR centered on the filing date (day following the filing date).
After Trading Hours (ATH)—an indicator with 1 if the 8-K form is filed after trading hours (4 p.m.–12 a.m.).
After Trading Hours on Last Trading Day (ATH on LTD)—an indicator with 1 if the 8-K form is filed after trading hours on the last trading day of the week.
Eastern Time Zone Indicator—an indicator with 1 if the firm headquarters are located either in the Eastern or Central time zone.
Form News—the news score obtained using the Loughran and McDonald (2011) financial-positive and financial-negative word lists; for each form, we compute the difference between the number of positive and negative financial words and scale the difference by the total number of words in the form.
Institutional Ownership—percentage of common shares held by institutional investors at fiscal year-end.
Last Trading Day (LTD)—an indicator with 1 if the 8-K form is filed on the last trading day of the week.
Log Market Value—natural log of market value of equity at fiscal year-end.
Mandatory News—News score calculated similar to Form News, over all items in the form except Item 8.01.
Number of Analysts—number of analysts who provided at least one forecast of next period earnings during the year.
Number of Items—number of unique items reported in the 8-K form.
Number of Segments—number of business segments.
Public Company Indicator—indicator with 1 if the firm shares are publicly traded (appear on CRSP).
Standard Deviation of Daily Return—computed based on daily stock returns during fiscal year.
Strategic Reporting—the total number of negative news forms reported after trading hours or on the last trading day of the week from the beginning of the sample period through the beginning of the year, scaled by the total number of 8-K form with negative news reported in the same period.
Voluntary News—News score calculated similar to Form News, over Item 8.01 only.
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Segal, B., Segal, D. Are managers strategic in reporting non-earnings news? Evidence on timing and news bundling. Rev Account Stud 21, 1203–1244 (2016). https://doi.org/10.1007/s11142-016-9366-y
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DOI: https://doi.org/10.1007/s11142-016-9366-y