Interaction between mandatory reporting and voluntary disclosure and their relevance to equity market and credit market

Zhang, Li (2010) Interaction between mandatory reporting and voluntary disclosure and their relevance to equity market and credit market. Doctoral thesis, University of London: London Business School.

Abstract

Mandatory financial reporting is subject to generally accepted accounting principles while voluntary disclosure such as management forecasts could be used by managers to reveal their inside information to market participants. This dissertation examines the interaction between mandatory reporting and voluntary disclosure and their relevance to equity market and credit market. Chapter 1 provides the outline of the dissertation and discusses the major contributions. Chapter 2 reviews previous literature and develops the hypotheses. Management forecasts about future earnings are sometimes issued along with current quarter earnings announcements, and these bundled management forecasts have recently become more prevalent. Using a composite measure of ex-ante management forecast accuracy that takes into account forecast ability, forecast difficulty and forecast environment, Chapter 3 shows that the bundled management forecasts can mitigate investors' under-reaction to current earnings and reduce the magnitude of post-earnings announcement drift only when these forecasts have high ex-ante accuracy. Firms have the incentive to cater for capital markets' demand in their financial reporting. Prior research has provided evidence that conservatism can lower the debt cost and solve the interest conflict between bondholders and shareholders. If firms anticipate market?s demand for conservatism before they issue public bonds, they will report more conservatively before issuing bonds for the first time. Using alternative measures of accounting conservatism, Chapter 4 shows that firms do report more conservatively before bond IPO. This result highlights the incremental importance of the debt market over the equity market in inducing conservative reporting and supports the argument that conservatism is more closely related with the debt market. Besides the equity market, management forecasts are also value relevant to the credit market. Chapter 5 provides the evidence that credit default swap (CDS) spreads react significantly and negatively to management forecast news, and that these reactions are stronger than those to actual earnings news. The credit market reactions to bad management forecast news and forecasts issued by credit risky companies are larger, reflecting the asymmetric payoff of debt securities. The impact of management forecasts on CDS spreads, relative to earnings announcements, also becomes stronger during the recent credit crisis when the market uncertainty is greater.