The readability of 10-K reports and insider trading profitability

This study links the readability of 10-K reports to insider trading profitability. Using a sample of 102,060 insider transactions in the United States between 1994 and 2016, we empirically demonstrate that less readable 10-K reports increase profitability from insider trading. Consistent with the proprietary cost argument, we also document that readability impacts on insider trading profitability are more pronounced for research and development–intensive firms, for firms facing higher product market competition and trade secrecy, and for firms with lower levels of voluntary management disclosures. Overall, this study supports the proprietary cost and strategic information asymmetry channel of readability and suggests that less readable reports lead to the exploitation of information advantages by insiders. JEL Classification: D4, G14, G34, G40

Litigation-Disclosure Modifications in the 10-K: Large-Sample Evidence

This study is the first to examine the litigation-disclosure modifications of legal proceedings (i.e., Item 103) and contingency-note disclosures (i.e., Accounting Standards Codification [ASC] 450) in the 10-K. Litigation-disclosure modifications are defined as the amount of litigation content disclosed in year t but not in year t– 1. I first confirm the Securities and Exchange Commission’s (SEC) and the Financial Accounting Standards Board’s (FASB) concern that firms are providing less litigation-disclosure modifications. I then find firms with higher proprietary cost, higher litigation risk, and non-Big 4 auditors to be associated with more litigation-disclosure modifications. I also find that although firms are providing less litigation-disclosure modifications in the two litigation sections, such disclosures do predict future occurrence of litigation cases and are complementary in providing litigation information to investors. Results indirectly support the FASB’s 2012 decision to not precede with disclosure policy changes in contingency-note disclosures.

On Market Concentration and Disclosure

Verrecchia (1983,1990) introduced the proprietary cost hypothesis in which exogenous disclosure costs are a reduced-form interpretation of lost competitive advantage in product markets. We develop a micro-foundation for this disclosure cost in a Cournot game and explicitly derive the cost as a function of market structure. When the market is sufficiently competitive, this model has a reduced-form representation similar to a standard voluntary disclosure game with a partial disclosure equilibrium. Proprietary costs are increasing in the number of competitors, the degree of product substitution, overall uncertainty and production costs. The analysis also offers new empirical predictions on the interaction between disclosure choice, managerial horizon and entry.

ANALISIS FAKTOR-FAKTOR YANG MEMPENGARUHI PENGUNGKAPAN VARIASI PERTUMBUHAN LABA ANTAR SEGMEN

Penelitian ini bertujuan untuk menguji dan menganalisis pengaruh proprietary cost, agency cost, financing incentives, dan pertumbuhan perusahaan terhadap pengungkapan variasi pertumbuhan laba antar segmen dengan variabel kontrol ukuran perusahaan pada perusahaan manufaktur. Desain penelitian adalah kuantitatif dengan hipotesis. Jenis data yang digunakan adalah data kuantitatif berupa laporan keuangan yang diperoleh dari website BEI. Objek penelitian adalah perusahaan manufaktur yang terdaftar di BEI. Teknik analisis data yang digunakan adalah analisis regresi linier berganda. Hasil penelitian menunjukkan pertumbuhan perusahaan berpengaruh negatif terhadap pengungkapan variasi pertumbuhan laba antar segmen. Proprietary cost, agency cost dan financing incentives tidak berpengaruh terhadap pengungkapan variasi pertumbuhan laba antar segmen.

Proprietary Costs and the Reporting of Segment-level Tax Expense

We examine whether proprietary costs of disclosure affect the reporting of segment-level tax expense. Current accounting rules for segment-level reporting afford managers significantdiscretion in what line items to report. We predict and find firms with higher proprietary costs of disclosure (i.e., higher tax avoidance) are less likely to disclose segment-level tax information. These results are stronger for firms that define business segments on a geographic basis, where disclosure could reveal tax expense information about specific tax jurisdictions, consistent with the proprietary cost hypothesis. Overall, our results suggest some managers potentially use discretion in current guidance to avoid segment-level disclosure of taxes when these disclosures have the potential to be detrimental to the firm.

Do Innovative Firms Communicate More? Evidence from the Relation between Patenting and Management Guidance

Successful innovations could induce more disclosure if the information asymmetry between the firm and its investors about post-innovation outcomes leads investors to demand more information. However, such innovations also likely entail greater proprietary cost concerns, which deter disclosure. This paper uses patent grants to examine the effect of innovation success on management guidance behavior. We find that more management guidance follows patent grants, suggesting that despite disclosure cost concerns, firms with successful innovations do respond to information demand. This association is stronger after enactment of Regulation Fair Disclosure and for firms with greater institutional investor ownership, further highlighting the role of information demand. The association is weaker for firms with more competition, consistent with proprietary cost concerns having a moderating impact. Overall, our findings suggest that innovation creates demand for more voluntary disclosure and firms' disclosure decisions following innovation outcomes vary in ways that disclosure theory and economic intuition predict.

The Effect of Trade Secrets Law on Stock Price Synchronicity: Evidence from the Inevitable Disclosure Doctrine

We exploit the staggered recognition of the Inevitable Disclosure Doctrine (IDD) by US state courts to examine the effect of trade-secret protection on the amount of firm-specific information incorporated in stock prices, as reflected in stock price synchronicity. We find that after certain state courts recognize the IDD, firms headquartered in those states exhibit a significant increase in stock price synchronicity relative to firms in other states. We also find a significant decrease in the disclosure of proprietary information in the firms' 10-K reports. These results suggest that IDD recognition increases the proprietary cost of disclosure, and, in response, corporate managers withhold more information. In addition, we find that the increase in stock price synchronicity and the decrease in the disclosure of proprietary information lead to increases in the firm's market share, cost of equity, and market-to-book ratio, suggesting that managers sacrifice capital market benefits for product market gains.

Managers’ stock-based compensation and disclosures of high proprietary cost information

Purpose The purpose of this study is to examine whether chief executive officers’ (CEOs’) stock-based compensation has any relationship with disclosure of high proprietary information. Design/methodology/approach Drawing on agency and proprietary cost theory, this study examines whether compensating CEOs based on equity value through the grants of stock option and restricted stock will affect different firms with high proprietary costs versus general costs of disclosures. The authors further explore the cross-sectional variation on the relationship between stock-based compensation and disclosures of high proprietary cost information. In particular, the authors examine certain circumstances under which stock-based compensation has a stronger effect in discouraging managers to make disclosures of product-related information. This study conducts an empirical investigation on the relationship by using hand-collected data on the product-related disclosures of biotechnology firms and by developing new disclosure indices to capture the product developments in the preclinical and clinical stages. Findings The authors find that on average, managers’ stock-based compensation does not have any significant relationship with the proxy of high proprietary disclosure index. More importantly, the authors find that managers with more equity-based compensation (in the total pay) make fewer disclosures of high proprietary cost information when they have a stronger need to protect such information. Specifically, the authors find a negative relationship between equity-based compensation and managers’ disclosure of high proprietary cost information when their firms’ product development is in early stage, when the corporate board mainly consists of directors with lack of sufficient knowledge on technology, and when firms are a leader in an industry in terms of market share. Research limitations/implications The authors acknowledge two limitations of the current study. First, the authors cannot completely rule out the possibility that the results are still subject to endogeneity issues such as reverse causality or omitted correlated variables even though the authors control for other important variables that affect disclosures and granting of stock-based compensation (including firm size, leverage, analyst following, institutional ownership and corporate governance) and use the lagged variable of stock-based compensation in the regression model. Second, given that the authors examine a small sample (only 10 per cent of firms in the biotechnology industry) due to the required hand-collection of product-related information, the generalizability of the results may be limited. Originality/value The study contributes to the literature in two important ways. First, the findings can add to the literature on the effect of stock-based compensation on managers’ disclosures. While previous studies suggest that compensating via stock options and restricted stocks can incentivize managers in enhancing firm disclosures in general (e.g. Nagar et al., 2003), the authors provide evidence suggesting that it may not always be the case. When disclosing information involves high proprietary cost, stock-based compensation can sometimes motivate managers not to reveal information. The study also complements Erkens (2011), who finds that firms offer stock-based compensation to their managers as an attempt to prevent the leakage of research and development (R&D)-related information to competitors. Second, the study can contribute to the extant literature that examines the importance of proprietary costs on firms’ disclosure decisions. The authors attempt to respond to the call for more research in this area (Beyer et al., 2010) by focusing on one specific industry, the biotech industry and by using a novel proxy for the proprietary costs based on the stage of product development for a drug-related product in that industry. As it has been challenging for researchers to properly measure proprietary costs of disclosures, the setting of the biotech industry provides a particularly strong empirical identification to potentially pinpoint the proprietary costs.