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Title: Strategic use of numeric volume in 10-K reports
Authors: Fu, Jiajia
Advisors: Cheng, C. S. Agnes (AF)
Su, Nancy (AF)
Keywords: Corporations -- Finance
Strategic planning
Issue Date: 2017
Publisher: The Hong Kong Polytechnic University
Abstract: Managers have considerable discretion over choosing the degree of quantification with numbers in the 10-K. This paper provides the first large-sample evidence on whether and how managers structure the numeric volume of annual reports to hide adverse information from investors. Specifically, I investigate whether managers limit the numeric volume of the 10-K to obfuscate future firm performance, and how investors react to such volume management. I view numeric volume as jointly determined by firm fundamentals and a discretionary component (referred to as abnormal volume) that could reflect manager's private information about future firm performance. I use industry-adjusted volume as a starting point to act as a proxy for abnormal volume. I also use (1) year-to-year change of numeric volume, and (2) the residual volume from the determinant model as alternatives to measure abnormal volume. Two main findings follow. First I find that abnormal low volume predicts poor future earnings and cash flows. This relation is more pronounced in firms where the market has greater difficulty in detecting managerial intervention in the disclosure process. Second, I find that abnormal low volume strongly predicts negative future returns, suggesting that managers benefit from disclosing fewer numbers by delaying the incorporation of bad news into stock prices. The zero-investment portfolio for abnormal volume yields an annualized DGTW adjusted return of 8%. Further corroborating my main results, I find that numeric volume is abnormally low when there exist strong managerial incentives to withhold bad news and/or manipulate investors' perception upwardly, such as just meeting or beating earnings thresholds and the equity incentives from CEOs. Overall, the evidence is consistent with my prediction that managers attempt to obfuscate future performance and inflate stock prices by disclosing fewer financial numbers in the 10-K.
It should be noted that this paper focuses on the volume of financial items that likely capture the whole information flow of the 10-Ks, as captured by Compustat. There are probably other ways in which managers attempt to inform or misinform investors by intervening the numeric volume in the 10-K. For example, do firms disclose more redundant numbers to increase investors' processing cost? Do firms disclose more good news items to distract investors' attention? Future research may explore these possibilities. This paper makes several contributions. Assessing whether reported financial statements are intentionally intervened (misstated or manipulated) and detecting the signals for the deterioration of future firm performance are of considerable interests to regulators, investors and researchers. This study is the first to show that abnormal numeric volume in the 10-K reveals managerial opportunism and can be used as a red flag of future performance deterioration. The economic impact of abnormal volume seems to be fairly large (annualized DGTW-adjusted return of 8% based on the zero-investment strategy of abnormal volume). Also, my study contributes to the strategic disclosure literature by discovering a new mechanism - numeric volume, through which firms can control information flow to the market, and revealing whether and when managers engage in volume management.
Description: viii, 86 pages
PolyU Library Call No.: [THS] LG51 .H577P AF 2017 Fu
Rights: All rights reserved.
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