The Name of the School
Research Question
Has the introduction in Australia of a continuous statutory-backed disclosure policy and subsequent amendments led to an increase in reporting of economic events experienced by firms? This is to verify that the legislation has relevance for firms.
Relationship of Proposed Study to Prior Research
The implementation of Australia's statutory-backed continuous disclosure policy is meant to make corporate behavior more transparent to stockholders. Under the disclosure regime, an Australian Stock Exchange-listed issuer is required to release material information about the company as soon as it becomes aware of it. The Australian Stock Exchange takes firsthand responsibility for regulating and monitoring itself. Statutory sanctions provide a regime of enforcement that will be implemented by a regulatory body such as the Securities Commission. As long as the statutory sanctions are effective, the players in the market will be better informed, which is ultimately the goal of the disclosure policy.
Statutory sanctions are economic sanctions. In the context of civil law, statutory sanctions are usually monetary fines. They may be levied against a party such as a corporation or individual for breaking a law. For example, statutory sanctions may require monetary punishment for abusing the judicial process or for violating procedure. In some cases, the attorney of the fined party may absorb the costs of the fine.
The statutory-backed disclosure policy, when enforced correctly, will enhance the protection of investors. The effectiveness of the policy should be tested, however. In order to test the effectiveness of the disclosure regime on such factors as the quality, timeliness, and quantity, certain measurements must be made. To test the frequency of disclosures of management earnings forecasts, company documents lodged with the Australian Stock Exchange must be thoroughly reviewed, both before and after the date that statutory sanctions were introduced into the system. By using regression models to control for certain factors, such as macroeconomic characteristics, industry, firm, and time, the disclosure behaviors can be made known.
Australia's continuous statutory-backed disclosure system will help reinforce the Australian Stock Exchange by adding an additional layer of policing to its disclosure rules. On the other hand, a statutory-backed continuous disclosure can cause problems for managers involved in high-growth firms. By making compulsory the full disclosure of project details, the firm's competitive advantage may be undermined. The can potentially encourage managers to be less transparent in their approach, which will counteract the goals of the policy. As a matter of fact, since the statutory-backed disclosure policy was adopted in 1994, firms have been found to be less likely to disclose their investment types. However, studies have also found that a significant increase in the likelihood of disclosure became apparent after stronger non-disclosure legislation was enacted in 2003. Tougher penalties for rule-breaking were also put in place in 2003. Nonetheless, research and development investments remain an area on which firms are reluctant to disclose, even in spite of the harsher penalties implemented starting in 2003. One interpretation of this finding suggests that companies are unwilling to bypass competitive advantages, which usually come about as a result of investments in research and development.
There is also evidence of an increase in announcement returns after the implementation of statutory-backed continuous disclosure policy. An earnings announcement is a statement of a company's profitability. If a company has been making a profit in the months leading up to the announcement, its share price will increase after the announcement has been made. Earnings announcements are usually made during the earnings season, and come after earnings estimates are predicted by equity analysts. That there was an increase in this type of official reporting by companies suggests that the statutory-backed continuous disclosure policy was effective at least in this regard.
The analysis examined in this report measures the impact of Australia's statutory-backed continuous disclosure policy by focusing on the propensity for investment disclosure. In addition, the analysis looks at investment announcement abnormal returns of more innovative investments. An abnormal return is a return that shows a high disparity between the expected outcome and the actual return on a security. A merger, interest rate increase, lawsuit, or a company earnings announcement can sometimes trigger an abnormal return.
CAPEX, or capital expenditures, were also investigated in the analysis. CAPEX investment disclosures were used as a benchmark by which to compare research and development and industrial technology disclosures. Capital expenditures are incurred when businesses spend money to add value to existing fixed assets, or to buy new fixed assets. Compared to capital expenditure disclosures, firms are less likely to disclose R&D investments.
Stock market efficiency and firm valuation rests upon the timely and accurate disclosure of information about financial entities. Disclosure benefits stockholders in many ways. It reduces information asymmetry, in which one party has more information than another, leading to a power imbalance in transactions. By helping to prevent information asymmetry, disclosure policies help prevent market failure that arises from information asymmetry. It also allows investors to be more savvy about the firm's future growth prospects, and allows them to make more informed choices about how much they invest.
Disclosure is also correlated with more efficient stock prices. This includes higher liquidity and lower bid-ask spreads. Higher liquidity refers to the greater availability of liquid assets, such as cash, to a company. A lower bid-ask spread means that the difference between the ask price for an asset and the bidding price that a buyer pays is reduced. Both these factors contribute to the health of the stock market.
Previous studies examined earnings announcement disclosures, including earnings forecasts for voluntary management. These studies showed significant announcement returns when analyst forecasts are disclosed. This prompted the enactment of the continuous statutory-backed disclosure policy in 1994. At the time that the legislation was put into place, it was thought to be a preferable alternative to a more regular reporting window, such as the quarterly reporting used in countries like Canada and the United States. Subsequent studies (Dunstan, Gallery, & Troung, 2010) found that the implementation of the disclosure policy did not improve timeliness of reporting, and showed that bad news events tend not be disclosed in as timely a manner as good news events. The findings also showed that increased litigation risk and monetary penalties spur managers to be more conservative in their disclosure. Nevertheless, there was also evidence found of increased non-disclosure for bad news events, meaning that while the reports were less verbose, they were also issued more frequently.
Other countries that have adopted continuous statutory-backed disclosure policy have found similar results (Dunstan, Gallery, & Troung, 2010). When New Zealand introduced continuous statutory-backed disclosure policy in 2002, it led to better precision and accuracy and an increase in frequency of voluntary management earnings forecasts. However, timeliness in the forecasts was also shown to decline.
Twenty-one years hence, it remains to be shown whether the introduction of continuous statutory-backed disclosure policy in Australia has been effective to increase and improve the reporting of price-sensitive innovative investment expenditures. The analyses of the policy have focused on firm investments primarily, because they are considered to be more significant than traditional capital expenditures (CAPEX) in encouraging competitive advantage. Thus, disclosure of of firm investments may be more prone to be opposed by management and may cause greater managerial conflict. Before the adoption of the policy, disclosure would lead to larger costs related to loss of competitive advantage than non-disclosure, through the loss of confidentiality of highly valued research and development findings. However, after the adoption of disclosure policy, the costs of non-disclosure exceeded the costs of disclosure due to statutory fines. Therefore, managers have become more likely to disclose the details of their investments, but they are less transparent when they do disclose.
As a comparison, the United States is a non-continuous statutory-backed disclosure policy environment. In the United States it is more common for firms not to release information about innovative investments because they fear losing their competitive advantage. Even major research and development events are not often disclosed to stock markets, such as success in clinical trials. One study (Koh and Reeb, 2014) showed that knowledge spillovers, at the input stage and the output (products and services), have very important economic implications for companies. Especially when a company is unable to fully take ownership of economic rents from investment, for example, if a rivaling company imitates its products, that company will avoid disclosure.
In Australia currently, penalties imposed by the Australian Securities Exchange make non-disclosure costlier than disclosure. This encourages managers to consider the net position (economic hit or gain) by weighing the benefits of non-disclosure against the costs. Prior studies (Hartford et al., 2014) have focused their analysis on firms that make innovative-type investments to test the impact of the change in disclosure regulation.
Australia's statutory-backed continuous disclosure policy has been amended several times since it was put in place in 1994 to increase the rate of compliance. However, the core of its regulatory objectives and requirements has remained intact. In the first three years following its adoption, it was severely criticized due to its lack of enforcement. For example, the Australian Securities Exchange made several recommendations for non-disclosure to the Australian Securities and Investments Commission (ASIC), although no fines were imposed on the companies involved. This led to a change in 1998 granting power to ASIC to levy enforceable undertakings on firms for noncompliance with the disclosure regulations.
Proposed Methods for Analyzing Research Question
This report proposes looking at the industry level to determine the relevance of the legislation to companies. This can be done by examining the industry return relative to the market return (market index) around the event dates. Since the impact of the legislation will likely have different costs for the different industries (tech, non-tech, competitive, concentrated), this should be reflected in the differences in returns across industries. It would be useful to compare the period before the policy was enacted and the years following the adoption of the regulatory legislation in order to gauge the measure's effectiveness.
Greater disclosure has an impact on investors' ability to accurately assess the value of firm investments. By providing more information about forecasted investment cash flows, growth, and financing, we should expect to find a reduction in information asymmetry and uncertainty. This should lead to a reduction in bid-ask spreads and a lower average dispersion in investor opinion. It should also reduce the frequency of insider trading (Dunstan, Gallery, & Troung, 2010).
An understanding of the implications of continuous statutory-backed disclosure policy on reporting behavior can help answer the question of whether disclosure likelihood differs across industries based on how competitive they are. It is expected that the costs of disclosure will be much greater for competitive industries, and therefore competitive industries are less likely to disclose.
Identification of Data Sources and Suitable Methodology
Australian Securities Exchange query data may serve as a data source for the investigation. In addition, the Australian Securities Exchange has listed all firm investment announcements between 1991 and 2012, including capital expenditure, research and development, and industrial technology investments.
References
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Harford, Jarrad, and Ronan Powell. 2015. Measuring the Effectiveness of Australia's Statutory-Backed Continuous Disclosure Policy on ‘Innovative’Investment Disclosures. CIFR Paper 51.
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Koh, P., & Reeb, D. 2014. R&D disclosures. Working paper, National University of Singapore.
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