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Investor Protection and the Information Content of

Annual Earnings Announcements:

International Evidence

Mark L. DeFond

Mingyi Hung

Robert Trezevant

University of Southern California

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Motivation

Investor Protection Institutions(Laws & Enforcement)

EarningsValue Relevance

•Long window studies.•Cannot tell us whether market uses earnings information

Prior research finds…

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MotivationWe examine Market Reaction to

Earnings Announcements (EAs)

•Tells whether earnings are USED

Try to identify Factors that affect Market

Reaction

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Purposes of Paper

1st Use Investor Protection Literature to identify Structural Factors that influence Information Content

2nd Test whether Structural Factors are Channels through which Investor Protection Institutions influence Information Content

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Information Content of Earnings

Announcements

Investor ProtectionInstitutions

Structural Factors inFinancial Reporting

Environment

Framework

OurHypotheses

Tests

PriorResearchFinds…

Tests of“Channel”

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Hypotheses development

Higher quality earnings likely to be more useful to investors

Hypothesis 1: Countries with higher earnings quality have

more informative annual earnings announcements

Measured derived from Leuz et al. (2003)

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Hypotheses Development

Stronger insider trading law enforcement • prices less likely to already impound the

information

Hypothesis 2:

Countries with stronger insider trading law enforcement have more informative annual earnings announcements

Measured as in Bhattacharya and Daouk (2002)

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Hypotheses Development More frequent financial reporting

• stock prices impound annual earnings information at an earlier point in time

Hypothesis 3:

Countries with more frequent interim earnings reporting have less informative annual earnings announcements

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Hypotheses Development Greater financial disclosure

• managers likely to disclose more information in earnings announcements (increase reaction)

• managers likely to disclose more information between announcements (decrease reaction)

Hypothesis 4: Greater financial disclosure in a country affects

informativeness of annual earnings announcements.

Measured with CIFAR index (Bushman et al., 2003, and many others)

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Data

53,197 earnings announcements 26 countries 1995 – 2002 Earnings and earnings announcement

dates -- I/B/E/S databases Daily stock returns – CRSP and

Datastream

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Table 2 – Panel B

AbnormalReturnVariance

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Average Abnormal Return Variance Bottom Three vs. Top Three Countries

Table 2, Panel B

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Italy South Africa Spain Netherlands U.S. U.K.

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Table 2 – Panel A

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Investor Protection ProxiesAntidirector Rights

Index based on company law or commercial code; sum of:

(1) Ability to vote by mail (2) Ability to control shares during S/H meeting (3) Possibility of cumulative voting for directors(4) Ease of calling an extra’y S/H meeting (5) Ease of minority investors to sue directors(LLSV 1997; Hung 2000)

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Investor Protection Proxies

Law Enforcement Institutions Mean of (each on scale of 1-10):

(1) Efficiency, integrity of judicial system

(2) Tradition of law and order

(3) Degree of government corruption

(LLSV 1998, Leuz et al. 2003)

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Hypotheses Test Dep Var = Abnormal Return Variance Ind Var = Structural Factors

+ Controls

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Channel Tests First, regress Abnormal Return Variance

on Investor Protection Variables

Second, regress Abnormal Return Variance on Structural Factors AND Investor Protection Variables

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Table 4, Panel BFirm Level Hypotheses Tests

 

 

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Table 4, Panel BFirm Level “Channel” Tests

 

 

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Supplementary Analyses

Four Supplementary Analyses

#1: Replace Abnormal Return Variance with Abnormal Trading Volume• Find Same result

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Supplementary Analysis #2Timing of Information Flow

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Supplementary Analysis #3Stock Market Efficiency

Tests assume stock markets reasonably efficient

Large firms, active analysts following

Prior research finds efficiency in a variety of countries (e.g., Bhattacharya et al., 2000; others)

International institutional investors do not do better than indexes (Cumby and Glen, 1990)

Additional analyses• Drop country with insignificant Abnormal Ret. Var.

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  Supplementary Analysis #4 ERCs and Investor Protection

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Robustness Checks Excluding U.S. and Japanese firms

Three-day announcement window

Controlling for capital market development

Controlling for industry effects

Controlling for time-series correlation

Deleting influential observations

Alternative Investor Protection measures

Ranked regression

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Limitations

Cross-country research design• Small number of degrees of freedom• Omitted correlated variables

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Contributions

Literature on X-Country Value-Relevance

•Short-window methodologyallows us to identify Structural Factors

Literature on Investor Protection •Identify Channels through which Investor Protection influences Information Content of Earnings

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Contributions

Overall Implication:

Strong IP engenders Financial Reporting Environments that have•Higher quality earnings•Equal access to information•More frequent reportingThe net effect of which is to increase the content of annual earnings announcements.