지리산 노고단

Timeliness and Informativeness of Fair Disclosure: Evidence from

Korean Preliminary Financial Reports

byInman SongYonhee Park

Dong-Hoon YangMahmud Hossain

2008. 8

Regulation of Fair Disclosure (Korean and US SECs)

Backgrounds of the Study(I)

• To prohibit “selective disclosure” of material

nonpublic information by listed firms

• To level the playing field for all investors by

mandating more timely disclosures that serves to

preempt insiders’information advantage

Current Korean Regulations for Disclosures System

Backgrounds of the Study(II)

• Securities Exchange Act Article 191-10, 3

• Regulations on listed company Article 4-2

Preliminary FinancialReports (PFR)

Sales revenue, operating income or net income of the recent fiscal year has changed more than 30%

Should be disclosed only prior to the “public notice date” (of shareholders’ meeting)

Closing date

Submission date (of financial statements to auditors)

Date of shareholders’

meeting

Audit report date (at which

the firm receives audit

reports)

Public notice date (of share-holders’meeting

)

Filing date (of audit report to shareholders)

Possible period of releasing PFRs

Backgrounds of the Study(III)

Problems with Current FD Regulations

Backgrounds of the Study(IV)

• PFR can be disclosed before “public notice date”

that is followed by “audit report date”

• As a result, firms may release PFRs even after

“audit report date” without violating the

regulation

May preempt the informativeness of PFR and

invalidate the effectiveness of the regulation

Research Questions

(Timeliness of FD)

Do Korean firms comply with the FD regulation requiring prompt notification of information about material changes in their financial performance?

(Informativeness of FD)

Are there differential market reactions to different timings of PFR disclosures?

Grant (1980)

Related Literature(I)

Finds that annual earnings announcements of OTC firms (with less amount of interim information) appear to possess more information content than those of NYSE firms

The information of the annual earnings announcement is

anticipated by the market prior to the date of release due to

the existing interim sources of information (as an alternative

form of PFR)

Firth (1981)

Related Literature(II)

Finds that week of the preliminary announcement gives the highest weekly level of “information”

Preliminary reporting pre-empts insider trading by putting

in the public domain information which would otherwise be

in the public domain

Opoong (1995 & 1996)

Related Literature(III)

Document that significant price response to the release of UK annual preliminary reports occur in hour (or day) in which the report is releasedPreliminary reports are still value relevant in spite of reliability

problems due to these reports not to subject to third party

certification

Song (1989), Jang and Cheon (2003)

Related Literature(IV)

Finds that substantial information is conveyed to the stock market by the release of voluntary preliminary annual financial reports

In contrast, information released at the annual shareholders’ meeting, which is subsequent to the release of preliminary annual financial reports, does not appear to give significant information to investors

Difference with Prior with Literature

Related Literature(V)

With respect to addressing potential preemption of actual earnings information of preliminary announcements, prior studies employ a firm’s annual announcement in its different stages:

- public notice date (Firth, 1981)

- date of shareholders’ meeting (Grant, 1980; Firth,

1981; Song, 1985; Jang and Cheon, 2005)

Failed to identify the earliest announcement date

of actual (i.e., certified) earnings to assess the

effectiveness of purported disclosure regulation

Empirical Model

Cart (-1,0,1) = a1 + a2 PUEt + a3DBPFR*PUEt + a4DNEG*PUEt + a5SIZEt

+ a6~8YD + etwhere, CAR(-1,0,1): cumulative abnormal return from “day -1” to “day +1”

(“day 0” day on event day)

PUE : unexpected PFR earning, (PFR NIt – actual NIt-1 )/ pricet-1

DBPFR : 1 if PFR is disclosed before audit report date, 0 otherwise

DNEG : 1 if net income is negative, 0 otherwise

SIZE: log(total market pricet-1)

YD: year dummies

Sample and Data Description of Sample Selection Procedure

Total observations on Korea Information Service-Financial Analysis System(“KIS-FAS”) data base and Data Analysis, Retrieval and Transfer(“DART”) system on FSS that satisfy all of the following initial sample criteria:(1)Korean Stock Exchange listing,(2)Fiscal year ending December 31, and(3)Availability of dates of relevant financial reporting events including audit report date, public notice date and filing date of audit report.

Less: Observations without the announcements of PFRs

Sub Total

Less: Observations with missing audit dates or public notice dates

Sample used to perform analysis of timeliness of PFR reports

Less: Observations with PFR releases later than 2 days of audit report date

Final sample for the test of market reactions to PFR announcements

1,852

(547)

1,305

(86)

1,219

(236)

983

Results: Timing of Disclosures(I)

Disclosure timing compared to PFR date

-22 or less

(-15) ~(-21)

(-8)~(-14)

(-1)~(-7)

0 1 ~7

8 ~(14)

(15) ~(21)

22 or more

Audit report date 80 86 146 241 51 419 114 48 34

Public notice date of shareholders’ meeting

26 1 11 10 63 267 268 203 370

Filing date of audit report to shareholders

1 4 35 165 196 611

Date of annual shareholders’ meeting

11 15 225 968

PFR Reproting Lag (N= 1,219)

604 (50%) sample firms release PFRs even after the audit report date

Results: Timing of Disclosures(II)

Over- vs. Under-estimation of PFR earnings Why tendency of late PFR disclosure?

More than half of sample firms (628) over- or under-estimate preliminary earnings , which may create unnecessary disclosure-

related legal liability

Year Discription No. of firms

PFR earning

s (A)

Audited

earnings (B)

Difference (A – B)

2001~

2004

Overstated 378 62,245 57,777 4,468

Understated 250 53,419 56,488 -3,069

No change 585 66,108 0 0

628 1,219

Results: Market Test(I)Market Reaction to Unexpected PFR Earnings around

PFR Release Date PFRs convey information to stock market only if they are disclosed prior to

audit report date

Model

Full Sample(n=983)

Full Sample with

DB*PUE(n=983)

Sub-sample with PFR release

before Audit Report Date

(n=490)

Sub-sample with PFR

release after Audit Report

Date (n=493)

Intercept  0.101( 3.36)*** 0.098( 3.33)*** 0.098( 1.46) 0.105( 2.00)**

PUE 0.002( 1.73)**  0.001( 0.70) 0.005( 2.07)** 0.001(0.38)

DBPFR*PUE  0.004( 1.66)*

DNEG*LOSS -0.044(-8.48)*** -0.044(-8.37)* -0.041(-4.39)*** -0.003(-5.46)***

SIZE -0.003( -2.81)*** -0.003(-2.80)*** -0.003(-1.16)** -0.047(-1.64)*

Adj R2 6.47% 6.61% 7.74% 6.65%

Results: Market Test(II)Market Reaction to Unexpected Actual Earnings

around Audit Report Date The informativeness of unexpected actual earnings is warranted only when

audit report date proceeds PFR release date

Model (n=1,663)

Basic Model Model 1 Model 2 Model 3

Intercept  0.105( 4.29)*** 0.086( 3.55)*** 0.085( 3.51) 0.085( 3.55)***

UE -0.001(-0.74) -0.001( -0.37) -0.002(-1.40) -0.001(-0.06)

DBPFR*UE

DAPFR*UE

DNOPFR*UE

---

0.002(0.52)--

-0.011( 2.84)**

*

-

--

0.007(0.57)

DNEG*UE -0.013(-3.34)*** -0.001(-0.21) -0.001(-0.37) -0.001(-0.19)

SIZE -0.003( -3.64)*** -0.002(-2.97)*** -0.002(-2.93)** -0.002(-2.97)***

Adj R2 1.47% 0.86% 1.30% 0.87%

Summary and Conclusions Half of sample firms release PFRs after the audit report date. PFRs are not preliminary any more since external auditing processes are substantially completed at audit report date

PFRs have information contents only if they are disclosed prior to audit report date. Consistent with the conjecture that timeliness increases the informativeness of PFR disclosure(by curbing insiders’ ability to potentially profit from their information advantages)

Implications for Accounting Policy Makers

Current regulation for PFR in Korea may not be effective to fulfill its main objective Necessary to amend current regulation to require that PFRs be released well before independent auditors complete the audit