Why Firms Voluntarily Disclose Bad News
Douglas J. Skinner
Journal of Accounting Research, Vol. 32, No. 1 (Spring, 1994), 38-60.
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‘Tue May 25 00:49:38 2004ourmal of accountag Resear
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Why Firms Voluntarily
Disclose Bad News
DOUGLAS J. SKINNER*
J. Introduction
This paper provides evidence on corporate voluntary disclosure
practices through an examination af the earnings-related disclosures
made by a random sample of 98 NASDAQ firms during 1981-90." [find
that, consistent with prior studies, earnings-related voluntary disclo-
sures occur infrequently (on average, one disclosure for every ten
quarterly earnings announcements); good news disclosures tend to be
point or range estimates of annual earnings-per-share (EPS), while bad
news disclosures cend to be qualitative statements about the current
quarter's earnings; the (unconditional) stock price response to bad
University of Michigan [thank J. Abarbanell, A. Alford, J: Anthony, M. Beth,
Bernard, M Beadley,D. Collins, H. DeAngelo, L DeAngelo, N. Dopuch, M. fokason,
P. O'Brien, V. O'Briex, K.Palepu, R Sloan, A. Suceney, C. Waymire, workshop partic
panty at Harvard University, the Universi of Towa, the University af Michigan, Michigan
Seste Univers, che Thira Conference on Finacial Economics and Accounting ot New
York Univecnity the University of Notee Dame, the Ohio State University, Purdue Us
serscy, Washingvon Usiversiy in St Louis, and Yale Universiy, nd especially evo anon
mous referees for helpful comments on previous versions, ad Li Li Eng and Michael
Mosebach fer research assistance. I aso appreciate comments by J. Caper Alexander,
J. Newer, J Seligman, and G.Siedel that helped me with the legal analyse the pape
Financial sapport from the KPMG Peat Marwick Foundation is gratefully acknowledged.
am respon for any remaining errors 9¢ amnion
Te earehed the Dow Jones Nous Retrieval Serie fr all statemneacs chat are atibueable
a the company oF its officials and thae convey information 2bout the Eem’s earaigs
prospects. This earch yielded point forecasts, range farecats, and wpper- and lower
bound forecasts, 24 well a8 qualitative statements about furure ceraings, Duclosures that
‘elated ta either annual and/or quacterly earnings wert included,
3
‘Capmigno iamtue of Froeasona! Accounting: 224WHY FIRMS VOLUNTARILY BISCLOSE BAD NewS 39
news disclosures is larger than the response to good news disclosures;
quarterly earnings announcements that convey large negative earnings
surprises are preempted about 25% of the time by voluntary corporate
disclosures while other earnings announcements are preempted less
than 10% of the time.
Overall, the evidence is consistent with the idea chat managers face
an asymmetric loss function jn choosing their voluntary disclosure pol
icies—managers behave as if they bear large costs when investors are
surprised by large negative earnings news, but not when other earnings
news is announced. There are at Jeast wo reasons managers may bear
costs as 2 result of large negative earnings surprises. First, stockholders
may sue when there are large stock price declines om earnings an-
nouncement days, since stockholders can allege that managers failed
(0 disclose adverse earnings news promptly. Managers can be held per-
sonally liable in auch suits, and their activities may he disrupted by hav-
ing to deal with this litigation.
Second, managers may incur reputational costs if they fail to disclose
bad news in a timely manner. Maney managers, stockhalders, security
analysts, and other investors dislike adverse earnings surprises, and
may impose costs on firms whose managers are less than candid about
potential earnings problems, For example, money managers may
choose not to hold the stocks of firms whose managers have a reputa-
tion for withholding bad news and analysts may choose not to follow
these firms’ stocks. These costs will affect managers’ disclosure deci-
sions as long as managers have an incentive to maintain the level of
heir firm’s stock price through some (unspecified) mechanism.”
Not all che sample disclosures about earnings convey bad news, and.
these other disclosures appear similar to those evaluated in previous
work, That is, they are typically point or range estimates of annual EPS
that generally convey either little information or good news (sce Lev
and Penman {1990] and Pownall, Wasley, and Waymire [1993] for ex-
ceptions). My evidence suggests thac by limiting cheir samples (0 point
or range forecasts of annual EPS, some previous papers appear co have
excluded an important subset of all voluntary disclosures, specifically
qualitative disclosures that. preempt the information in quarterly earn-
ings releases
The next section of the paper lays out why securities laws may mod
vate managers to preempt bad quarterly earnings news. Section $ sum-
marizes existing accounting research on discretionary disclosure, and
section 4 details the research hypotheses. Section 5 describes the sample
* Recent analyical research suggests that managers disclose bad news to deter enc!
competition in their frm’ product markers (eg, see Daraugh and Scoughuon (1990)
and Newnan and Sansing [1893]} or to goal their “qualiy” (Teoh and Hrsg (199 (]}
However, ic seems unlikely that the exeningsrelated bad news disclosures in this sudy
are driven by these incentives.