an empirical analysis of the quality of corporate financial disclosure

An Empirical Analysis of the Quality of Corporate Financial DisclosureAuthor(s): Surendra S. Singhvi and Harsha B. DesaiSource: The Accounting Review, Vol. 46, No. 1 (Jan., 1971), pp. 129-138Published by: American Accounting AssociationStable URL: http://www.jstor.org/stable/243894 .Accessed: 03/04/2011 11:51

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An Empirical Analysis of the Quality of Corporate Financial Disclosure

Surendra S. Singhvi and Harsha B. Desai

IN A free enterprise system, variations in corporate disclosure practices are likely to result since corporations are

managed by groups which have varying managerial philosophies and wide discre- tion in connection with disclosing information to the investing public. The quality of corporate disclosure influences to a great extent the quality of investment decisions made by investors. This study attempts to identify some of the characteristics of corporations in the United States which are associated with, and the probable implications of, the quality of corporate disclosure.

RESEARCH DESIGN

Corporate disclosure of information can take several forms and the annual report to stockholders is a very important form of periodical corporate disclosure. The empirical work in this paper is limited to stockholder annual reports of 100 listed and 55 unlisted corporations for fiscal years ending between April 1, 1965, and March 31, 1966. Annual reports of the listed corporations were selected by taking a random sample from the 500 largest United States industrial corporations included in the Fortune's directory of 1965. Annual reports of the unlisted corporations were selected, using a systematic sampling procedure, from the National Over-the-Counter quotations of about 800

corporations published in the New York Times. On this basis, a letter requesting the annual report was mailed to 100 such corporations but only 55 corporations complied with the request.'

In order to evaluate the quality of information disclosed in annual reports, an index of disclosure with 34 items is used which is similar to the one used by Cerf.2 His index consists of 31 items, out of which three items, viz. physical volume of pro- duction, method of depletion, and results of exploration, are excluded here since these items are more relevant to wasting assets corporations than to non-wasting assets corporations. The last six items of the index used in this study are added on the basis of the need for these items ex- pressed by several writers.'

The authors are thankful to the Division of Research, School of Business Administration, Miami University, for a modest research grant to complete the project.

1 For details on the procedure of selecting these corporations and their names, see the doctoral disserta- tion of Surendra Singhvi, "Corporate Disclosure through Annual Reports in the U.S.A. and India," (Graduate School of Business, Columbia University, 1967).

2 See, Alan R. Cerf, Corporate Reporting and Invest- nment Decisions (The University of California Press, 1961), pp. 25-27.

' See for example, Richard D. Bradish, "Corporate Reporting and the Financial Analyst," THE AccoLNr-

Surendra S. Singhvi is A ssociate Pro- fessor of Finance and Harsha B. Desai is Assistant Professor of Business A nalysis at Miami University.

129

130 The Accounting Review, January 1971

Initially, the items in the index were selected by Cerf on the basis of a study of the investment decision process, a review of the literature on how the decision should be made, interviews with security analysts, and an examination of analysts' reports. Weights are assigned to the items in order to note distinction in their relative im- portance as indicated by the various sub- committees of the Committee on Cor- porate Information, and also indicated by the security analysts who were interviewed. Total weights given to all items equal 68. The items included in the index are classified into four categories and are given different weights ranging from 1 to 4. However, there is no linear relationship in assigning different weights to the items in the index; e.g., items weighted 4 are not four times as necessary as items weighted 1.

In the course of interviews with several experts in the field, the appropriateness of the items in the index was discussed. All of them stated that the information included in the index was adequate for an investment decision. Some of them suggested inclusion of items such as the address of the corporate headquarters and time and place of the annual meeting, while one senior analyst suggested giving more weight to items such as backlog and projections. Though the inclusion of the items and the assignment of the weights are not completely objective, it is assumed that if investors had the information included in the index, they would have most of the important financial information necessary to make an informed investment decision.

To test the effectiveness of the index, the results of this study were compared with those of the twenty-sixth annual survey by Financial World in 1966. The survey included more than 5,000 annual reports and nearly 1,950 annual reports received a Merit Award Certificate for meeting the minimum disclosure require-

ments set by Financial World. The top 23 percent of the 155 annual reports selected in this study were also selected by Finan- cial World for Merit Award Certificates. Out of the bottom 23 percent of the reports, only 9 reports were selected by Financial World for this award."

Using the index, the quality of disclosure in annual reports is quantified. Corporations, on the basis of their disclosure scores, are classified into several categories. While determining the number of categories for analysis of scores, it is considered appropriate that each category contain a fairly representative number of corporations to avoid the influence of an extreme value on the average for a particu- lar class. In order to test the significance of the relationship between the quality of disclosure and various characteristics, a multivariate analysis is done.

The term adequate corporate disclosure is used very frequently in the paper. Al- though adequate corporate disclosure is a relative matter, an approximate model of adequate disclosure is developed in this paper. The index of disclosure, as shown in the Appendix, is an approximate model of adequate corporate disclosure. The model includes information on financial and non- financial matters related to the past, present, and future of the corporation.

ING REVIEW, XL (October 1965) pp. 757-66, and; Cor- liss D. Anderson, Corporate Reportingfor the Professional Investor (Auburndale, Massachusetts: Financial Anal- ysts Federation, 1962).

' The following persons were interviewed on the date indicated within parentheses: Walter P. Stern, Partner, Burnham and Company, New York and one of the judges for the 26th Annual Report Survey conducted by Financial World (August 12, 1966); Bert R. Haas, Senior Analyst, Paines, Webber, Jackson and Curtis, New York, and the chairman of the Corporate Rela- tions Committee of the New York Society of Security Analysts (October 3, 1966); Glen P. Caterer, Vice Presi- dent, Lionel Edie and Company, New York, and a member of the Committee on Corporate Information (October 11, 1966); and B. V. Wright, Jr., Senior Analyst, Model Roland and Company, New York, and a member of the Committee on Corporate Information (October 11, 1966).

' See Financial World, CXXV (June 29, 1966), pp. 47-70.

Singhvi and Desai: Corporate Financial Disclosure 131

CHARACTERISTICS ASSOCIATED \WITH

THE QUALITY OF FINANCIAL DISCLoSURE

Using the research design previously discussed, certain characteristics of corporations associated with the quality of financial disclosure are examined. The quality refers to completeness, accuracy and reliability. The assumption here is that the quality of disclosure in annual reports is not an independent variable; rather it is likely to be influenced by several variables.

In the study by Cerf, it was pointed out that the quality of disclosure is influenced by a variety of variables, and often there is an interdependence between these variables.6 Cerf's study is very interesting since it is the first of its nature to show empirically such interdependence. One drawback of the study is that the significance of these relationships is not tested in statistical terms. Analysis by means of classes, as Cerf has done, is not sufficient. Since each class does not have an equal number of observations, the average for a class is likely to be influenced by extreme values.

The present study is undertaken to examine the variables having influence on the quality of disclosure for the following reasons:

1. Cerf's study is based on annual reports which are a decade old. The present study updates his work by retesting his hypotheses related to the stock trading on the New York Stock Exchange v. over-the-counter, size of the corporation and its profitability as measured by the rate of return.

2. The present study also examines additional variables which were ne- glected in Cerf's study, such as the influence of the CPA firm and the corporation's earnings margin.

3. Significance of the relationship between the quality of disclosure and several variables is tested in statistical terms.

The variables examined in the present study are assets size (A), number of stockholders (N), listing status (L), CPA firms (C), rate of return (R) and earnings margin (E). The conceptual relationship between the index of quality of disclosure (I) and the above-mentioned variables is of the following order: (I) = f (A, N, L, C, R, E).

(1) Assets Size: The size of a corporation is measured in this study by its total assets. A positive relationship between the assets size of a corporation and the quality of disclosure can result for many reasons. First, the cost of accumulating detailed information is relatively high for smaller corporations. In larger corporations, such information is accumulated for internal reporting to top executives and, therefore, disclosure of such information is not a costly affair for them. Second, the management of larger corporations is likely to realize the possible benefits of better disclosure, such as easier marketability of securities and greater ease in financing. Smaller corporations usually do not raise funds in the securities market and, therefore, cannot realize the possible benefits of better disclosure. Last, smaller corporations are likely to feel more than larger corporations that the full disclosure of information could endanger their com- petitive position.

Table 1 shows a positive relationship between the assets size of a corporation and the quality of disclosure for the listed and unlisted corporations. Though the assets size is a key variable in influencing the quality of disclosure, the listing status also influences the quality of disclosure. In the present sample, there are not enough listed and unlisted corporations in

' See Cerf, op. cit., pp. 31-32.


TABLE 1

ASSETS SIZE AND QUALITY OF DisCLosuRE

AU Listed Unlisted Assets Size Corporations Corporations Corporations

(in million $) n i n i n i

Less than 10 19 32.4 - - 19 32.4 10-20 19 34.0 - - 19 34.0 20-80 20 36.5 5 37.6 15 36.2 80-130 21 40.6 21 40.6 - - 130-200 15 41.6 14 42.6 1 28.0 200-300 20 42.5 19 43.2 1 19.0 300-500 13 43.0 13 43.0 - - 500 & above 28 46.1 28 46.1 -

Total 155 100 55

Note: n=number of corporations; x=mean disclosure scores. Results significant at 0.01 level with Chi- square test. A comprehensive multivariate analysis follows.

any assets size class to see if the listing status has any influence on the quality of disclosure. However, the mean score for the third assets size class ($20-80 million) is slightly higher for the listed corporations than for the unlisted corporations.

(2) Number of stockholders: The owner- ship distribution has a significant influence on the quality of disclosure in annual reports. A positive relationship between the number of stockholders and the quality of disclosure can result for many reasons. First, corporations with a large number of stockholders tend to be more in the public eye and are, therefore, more subject to stockholders' and analysts' pressures for better disclosure. Second, corporations with a large number of stockholders may disclose more information in order to minimize excessive pressure from regula- tory agencies. Third, in order to promote the marketability of the corporate securities, corporations with a large number of stockholders may disclose more information. Last, as the number of stockholders increases, the corporations are likely to disclose more information than the nonprofessional managers because the former group is relatively more conscious

of its social responsibility than the latter. Table 2 shows a positive relationship between the number of stockholders and the quality of disclosure.

(3) Listing status: The quality of disclosure in annual reports is influenced to a great extent by the listing requirements of a stock exchange. The New York Stock Exchange, for example, requires that an original listing application be filed and made available to the public to provide sufficient information to make judgment of the merits of the security. The corporations must keep the information filed as part of the original listing application up to date, and they must agree to publish financial reports regularly.7 The rules and regulations of both the American and Pacific Coast Stock Exchanges are similar to those of the New York Stock Exchange, while the rules and regulations at the remaining stock exchanges are less demand- ing as compared to those of the New York Stock Exchange. Regarding over-the- counter corporations, the National As- sociation of Security Dealers (NASD) requires the corporations, which want their security prices to be released, to make available to the public their financial statements at least once a year through

I Requirements to specific items in the financial report are listed under section A-A of the New-t York Stock Ex- change Company Afanual, published by the Exchange.

TABLE 2

NUMBER OF STOCKHOLDERS AND QUALITY OF DiscwsuRE

Number of Number of Mean Stockholders Corporatiots Scores

Less than 3,000 35 34.48 3,000-10,000 50 38.40 10,000-25,000 30 43.56 25,000-and over 36 44.58

Total 151*

* The number of stockholders is not available for four corporations. Results significant at 0.01 level with Chi- Square test.


the press or some financial service. The NASD, however, does not specify the contents to be included in the company's financial statements.

Corporations whose stock is traded on a national stock exchange fall under S.E.C. reporting requirements, whereas firms traded over-the-counter do not unless they fall under Section 15(d) of the Securities Exchange Act of 1934. Section 15(d) is applicable, under the Securities Acts Amendments of 1964, to an issuer with total assets in excess of $1 million and a class of equity securities held of record by 500 or more persons.8 Since listed corporations have to follow regulations of a stock exchange as well as the S.E.C., their annual reports are likely to be better in content than those of the unlisted corporations. Table 3 shows that the average quality of disclosure is better for the listed corporations than for the unlisted corporations.

(4) CPA firm: A CPA firm has a certain degree of influence on the amount of information disclosed in financial statements but the degree of influence may differ from one CPA firm to another.9 Usually the CPA firms are concerned with a minimum standard. One of the generally accepted auditing standards is that "in- formative disclosures in the financial statements are to be regarded as reason- ably adequate unless otherwise stated in the (auditor's) report."10 What this "rea-

TABLE 3 DISCLOSURE SCORES FOR LISTED AND

UNLISTED CORPORATIONS

Type of M can Standard Sample Corporation Scores Range Deziation Size

Listed 43.08 24-58 5.65 100 Unlisted 33.70 19-47 5.79 55 All 39.80 19-58 6.99 155

Note: The difference between the mean scores of listed and unlisted firms is significant at 0.01 level with Z Test.

TABLz 4 CPA FIRaS AN QuArY oi DiscLosuE

CPA Firms

Type INumber Number of Mean ______b I _________Corporations Scores

Large 8 133 40.43 Small 16 21 36.38

Total 24 154*

* The annual report of one corporation does not include the auditor's opinion. The difference between the mean scores of firms audited by large and small CPA firms is significant at 0.01 level with Z Test.

sonably adequate standard of informa- tive disclosure" really represents is for practical purposes left to the judgment of individual CPAs. It should be pointed out, however, that over the last few decades certain minimum standards have been developed, usually based on either the stock exchange or S.E.C. requirements, which would be enforced by all the reputable CPA firms.

Table 4 shows a positive relationship between the type of a CPA firm and the quality of corporate disclosure. In order to determine the types of CPA firms, all CPA firms whose opinion is in annual reports included in the sample are classified into two classes: large CPA firms and small CPA firms. According to the esti- mates of gross revenue made by Fortune in 1960, the following are the largest eight CPA firms in the United States: (i) Peat Marwick Mitchell and Company, (ii) Arthur Andersen and Company, (iii)

8 For section 15 (d) see, U.S., S.E.C., Securities Ex- change Act of 1934, as amended to August 20, 1964 (73rd Congress, H.R. 9323), p. 19; also see, U.S., S.E.C., Summary of the Securities Acts Amendments of 1964, Securities Act of 1933, release no. 4725, and Securities Exchange Act of 1934, release no. 7425, September 15. 1964, p. 3.

9 See John L. Carey, The CPA Plans for the Future (The American Institute of Certified Public Accoun- tants, 1965), pp. 128-33.

10 American Institute of Accountants, Generally Ac- cepted A editing Standards: Their Significance and Scope. A Report prepared by the Committee on Auditing Pro- cedure (American Institute of Accountants, 1954), p. 14.


TABLE S

RATE OF RETruRN AND QUAUTY or DissCiosuv

Rate o All Listed Unlisted Return Corporations Corporations Corporations

(in percent) n n i n

Loss to less than 10 46 38.7 29 42.9 17 31.6

10-15 56 40.1 41 43.0 15 32.2 15-20 33 42.0 20 44.7 13 38.0 20andup 20 37.2 10 40.9 10 33.6

Total 155 100 55

Note: Results significant at 0.02 level with Chi- Square test.

Ernst and Ernst, (iv) Price Waterhouse and Company, (v) Haskins & Sells, (vi) Lybrand, Ross Bros., and Montgomery, (vii) Arthur Young and Company, and (viii) Touche Ross & Company (formerly Touche, Ross, Bailey and Smart).'1 In this study these eight CPA firms are classified as large and the remaining CPA firms are small.

(5) Rate of return: Variability in the quality of disclosure can be explained to some extent, by differences in the rate of return. Rate of return is defined as a ratio of net profit to net worth. Such rate of return is generally considered as a measure of good management. WINhen the rate of return is high in a corporation, the management may disclose detailed information in order to support the continuance of its positions and compensations. On the other hand, when the rate of return is low, the management may disclose less information in order to cover up the reasons for losses or declining profits. The corporate management is reluctant in giving information on earnings or sales breakdown by divisions particularly when one or more of the divisions are unprofitable. Instead, management discloses its total profit figure so that divisional downward trends are hidden in the whole. Table 5 shows a positive relationship between the quality of disclosure and the rate of return.

One observes in Table 5 that the average quality of disclosure slows down for the corporations which are in the highest rate of return class. To find out the reasons for this situation, twenty corporations- ten listed and ten unlisted-in the highest rate of return class are carefully examined. It is found that a majority of these corporations rely to a great extent on their internal sources of financing. In 1965-66, for example, these corporations ploughed back more than two-thirds of their earnings. It was also found that a great majority of these corporations did not raise funds frequently by issuing new common stocks to investors during the last five years. Since internal sources of financing are given an important place by these corporations and they did not go to the market frequently, the management may tend to give less attention to the needs of the investing public in connection with disclosing information;

(6) Earnings margin: Another measure of a firm's profitability is the earnings margin. Earnings margin is defined as a ratio of net profit to net sales. The rate of return measures the over-all performance of a business while the earnings margin shows the corporation's capacity of absorbing rising costs.

The higher the earnings margin, the greater will be the capacity of the corporation to absorb rising costs, and the more stable and successful will be the corporation. Also the higher the earnings margin, the stronger will be the corporation's position in the price competition. If a corporation's earnings margin is very low, its competitors may squeeze it out of the market by reducing the product's price. When a corporation's earnings margin is above the average for the industry, the

11 An analysis of the CPA firms, auditing annual reports of the 500 largest corporations, supports the classi- fication of CPA firms into large and small in the present study. Also see, T. A. WVise, "The Aucitors Have Ar- rived, Part I," Fortune, LXII (November 1960).


investing public is likely to have greater confidence in the corporation for its sur- vival. The corporation may disclose more information when its earnings margin is above the average for the industry because it is not afraid of being squeezed out in the price competition, and also it wants to assure its stockholders about the corporation's strong position to survive.

Table 6 shows a positive relationship between the earnings margin and the quality of disclosure. Similar to the rate of return variable, the average quality of disclosure slows down for the corporations which are in the highest earnings margin class.

Multivariate A analysis: Using a multivariate linear regression model, the estimated (I)=30.90+0.70 (A)+0.0060 (N) +8.10 (L)+2.21 (C)-0.03 (R)+0.25 (E) where,

I= Index of Quality of disclosure A = Assets in billions of dollars N= Number of stockholders in thou-

sands L = Listing status, (L = 1= listed; L =0

= Unlisted) C=CPA Firm (C= 1= Large firm; C=0

= Small firm) R= Rate of return in percentage

and E= Earnings margin in percentage.

The estimated values for the constant term (30.90) and the regression coefficient (8.10) for listing status, L, are significant at 0.01 level. Though the regression coefficient (0.25) for earnings margin is not statistically significant, its significance lies in the "gray area" of 0.05 and 0.10 level. The regression coefficients for the remaining variables are not statistically significant.

The coefficient of multiple determina- tion, R2, is 0.43442, and the sum of squares due to regression is significant at 0.01 level. In other wNords, 43.4% varia-

TABLE 6

EARNINGS MARGIN AN?D QuALiTY o DiscLOsURz

Margin Corporations C4 aons Corporatins (in percent) 2 n i f

Loss to less than 23 17 36.0 9 40.6 8 30.9

2j-5 36 39.0 22 42.3 14 33.6 5 -7j 46 40.4 33 42.6 13 34.9 7j+-10 29 41.8 19 45.6 10 34.4 lOandup 27 39.9 17 43.4 10 33.7

Total 155 100 5S

Note: Results significant at 0.05 level with Chi- Square test.

tion in the quality of disclosure can be explained by the variables under consider- ation.

The multiple coefficient correlation, R, is 0.66 (significant at 0.01 level, n= 155). Further, listing status, L, taken alone explains 38.13%o variation in the quality of disclosure and the coefficient of correlation for L and I is 0.62 (significant at 0.01 level, n= 155) 12

Since the variable, listing status, re- vealed a large portion of the explained variation in the quality of disclosure, two additional analyses were carried out for listed and unlisted corporations sepa- rately. As anticipated, the value of R2

dropped to 11.23%0 for the listed companies (significant at 0.02 level, n= 100), and to 26.11%o for the unlisted companies (significant at 0.01 level, n=55).

It should be pointed out that the statistical significance of the results does not establish a cause and effect relationship. However, an attempt has been made to provide a rationale for relationships among different variables included in this study.

U1 Using Ohio State University's stepwise regression program, the order of entrance of the variables was listing status (L), assets size (A), CPA firm (C), earnings margin (E), number of stockholders (N), and rate of return (R). The analysis on the residuals shows nor- malcy.


LIKELY IMPLICATIONS OF INADEQUATE FINANCIAL DISCLOSURE

One of the likely implications of inadequate corporate disclosure is the greater price dispersion in the securities market. Stigler writes, "Price dispersion is a man- ifestation-and, indeed, it is a measure- of ignorance in the market."'3 Adequate disclosure of information minimizes ignorance in the market and causes the market price to reflect the true value of the security; consequently, the price dispersion is narrowed down.

True value or intrinsic value of a security, by definition, is "that value which is justified by the facts, e.g., assets, earnings, dividends, definite prospects, includ- ing the factor of management."' The current market price, on the other hand, is the price at which securities are quoted. Dispersion between the market price and the instrinsic value of a security in part is the result of the quality of information- the more superior the quality of information disclosed, the lower will be the price dispersion. Investors tend to buy securities at a price which is higher than the intrinsic value, or they sell at the price which is lower than the intrinsic value for several reasons, and one of the reasons is the lack of information which is necessary to determine the intrinsic value of the security.

With full disclosure of information, one would expect less drastic shifts in esti- mates of expected profitability of a given issue, a greater scope for scientific investment analysis, a diminished reliance on and use of rumors, a reduction in the scale of manipulation practices, and a narrower dispersion between the intrinsic value and market price of a security."5

In the absence of adequate corporate disclosure of information, dispersion in the market price of a security is likely to be wider than what it would be otherwise. Consequently, some corporations sell their

securities at a price which is higher than the intrinsic value of the security, while others sell for less than the intrinsic value. The cost of capital in the former case, therefore, is likely to be lower than in the latter case if the intrinsic value of the security is the same for both. This shows that investment decisions by the investing public affect the price of capital in security markets, which in turn affects decisions by corporate managements as to investment of funds in new capital goods or in inventories. If the cost of capital is relatively high in a given period, the cut- off rate for accepting investment projects will be relatively high, and several projects with lower rate of return but useful to the economy probably will be rejected. These decisions, in this manner, affect allocation of resources and are likely to have major implications for the main- tenance of a high level of business ac- tivity, employment and economic growth.

Security prices are divorced from the intrinsic value when adequate information about corporate affairs is not available. Since the intrinsic value is based on the earnings potential of a corporation, in addition to other factors, the security prices are in fact divorced from the earnings potential when adequate information is not available. The stock market under these circumstances cannot be expected to serve as an effective disciplinary force capable of pressing management to main- tain the efficiency of corporate operations.

This study provides empirical evidence in connection with the likely influence of corporate disclosure of information on security prices. Table 7 shows that the

13 George J. Stigler, "The Economics of Information," The Journal of Political Economny, LXIX June 1961), p. 214.

" Benjamin Graham, David L. Dodd and Sidney Cottle, Security Analysis (4th edition, McGraw-Hill Book Company, Inc., 1962), p. 28.

15 Irwin Friend and E. S. Herman, "The S.E.C. through a Glass Darkly," The Journal of Business, XXXVII (October 1964), p. 391.


TABLE 7

QUALITY OF DISCLOSURE AND FLUCTUATIONS BY SECURITY PRICES

All Listed Unlisted Disdosure Corporations Corporations Corporations

Scores n x n I n x

50 and up 10 38.70 10 38.70 - 40 to 49 74 50.22 65 49. 73 9 53.77 30 to 39 51 55.39 22 53.59 29 56.75 Below 30 15 61.06 2 64.50 13 60.53

Total 150* 52.30 99 51

Note: Results significant at 0.05 level with Chi- Square.

* Price quotations are not available for two corporations. Price fluctuations for other three corporations are above 250 percent and, therefore, these corporations are eliminated here so that the average for any class may not be influenced by an extreme value. Price quotations are taken for 1965 from Standard and Poor's, Security Owner's Stock Guide, XX January, 1966).

superior quality of disclosure is related on an average with the lower price fluctuations. Fluctuations in the security prices are measured by taking the differences between high and low prices of a security for a given year and dividing it with the low price for the same year.

Statistical A analysis: The following model was developed to quantify the conceptual- ized relationship between the price dispersion and the quality of disclosure:

P = C1 - C2(I)

where,

P= Percentage Price Dispersion Cl = Constant > 0 C2= Constant > 0 1= Index of quality of disclosure.

This relationship suggests that as (I) increases, (P) tends to decrease and vice- versa. Using the above model, the following results were obtained: the estimated (P) = 78.53-0.66 (I).

Although, the coefficient of determina- tion, R2, is small (approximately 2%, probably due to large standard deviation = 34.15 obtained for P), the sum of squares

due to regression is significant at 0.01 level. The coefficient of correlation, (R =-0.13729) is also significant at 0.05 level. The sample size here is 150 companies as discussed earlier.

SUMMARY ASNAD CONCLUSION

This study demonstrates that the corporations which disclose inadequate information are likely to be: (a) small in size as measured by total assets, (b) small in size as measured by number of stockholders, (c) free from listing requirements, (d) audited by a small CPA firm, (e) less profitable as measured by rate of return, and (f) less profitable as measured by earnings margin.

It has also been demonstrated empirically in this study that inadequate corporate disclosure in annual reports is likely to widen fluctuations in the market price of a security since investment decisions, in the absence of adequate information, are based on less objective measures. These fluctuations, which affect the cost of capital and the corporate management's decision to invest funds, lead to inefficient allocation of capital resources in the economy. The market system, under these circumstances, becomes a less efficient allocator of the nation's resources. In brief, it can be said that the quality of disclosure is one of the variables which has effect on the price of a security.

As corporate disclosure increases, the variations in the market price of a security tend to narrow down, and this may further reduce excessive speculation and gambling in the securities market. It is also likely that the corporations with poor earnings, when required to disclose full and fair information, might be weeded out of the securities market because it will be difficult for such corporations to raise capital at a reasonable cost. With adequate and accurate information available, the investing public will have more


confidence in the securities market and the number of investors is likely to increase.

APPENDIsx

INDEx oF DiscLOsuRE

Items of Information W1'eight 1. Comparative Income Statement for 2 years 4 2. Comparative Balance Sheet for 2 years.... 4 3. Statement of reconciliation of earned surplus 3 4. Statement of cash-flow (or source and app!i-

cation) ........................... 3 5. Summary of important financial statistics

10 years =3 points 4-5 years= 1 point 6-9 years=2 points 3

6. Method of inventory valuation ........... 1 Basis of inventory valuation .............. 2

7. Sales breakdown by division or by individual companies in a consolidated statement .... 3

8. Method of depreciation ........ .......... 3 9. Description of type of capital expenditure

planned ................................ 3 10. Capital expenditure amount for current year 3 11. Research expenditure amount for current

year ................ . ... 3

12. Statement of gross and net property accounts 2 13. Sales broken down by customers or industry

served .................. 2 14. Sales separated by major product lines.... 2 1'. Discussion of major factors affecting future

business ............................... 2 16. Information on labor contracts ........... 2 17. Basic policies and objectives of management 2 18. Description of principal plants ............ 2 19. Details of outstanding stock issues ........ 1 20. Index of selling prices ................... 1 21. Index of raw material prices ... .......... 1 22. Discussion of new product development.... 1 23. Discussion of industry trends ............. 1 24. Number of employees .................... 1 25. Description of management .............. 1 26. List of names of directors ................ 1 27. Summary of major products produced .... 1 28. Information on tax clearances & pending tax

claims ................................. 1 29. Advertising expenses for current year..... . 2 30. Contingent liabilities ..................... 2 31. Inventory breakdown ................... 2 32. Sources of other earnings ................. 1 33. Backlogs and projections ................. 1 34. Number of stockholders ................. 1

Total number of weights 68

an empirical analysis of the quality of corporate financial disclosure

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