The Informativeness of HistoricalFinancial Disclosures
Michael S. Drake
Marriott School of Management
Brigham Young University
Darren T. Roulstone
Fisher College of Business
The Ohio State University
Jacob R. Thornock
Foster School of Business
University of Washington
November2012
We are especially grateful to Scott Bauguess and many others at the Securities and Exchange Commission and to Dick Dietrich for assistance in acquiring and implementing the proprietary data used in this study. We thank Scott Bauguess, Anne Beatty, Bob Bowen, Jonathan Brogaard, Nicole Cade, John Campbell,Ed deHaan, Thomas Gilbert, Frank Hodge, Dawn Matsumoto, Kathy Petroni, Terry Shevlin and workshop participants at the2012 UBCOW Conference, 2012 Chicago Quantitative Alliance Annual Academic Competition, Brigham Young University,Massachusetts Institute of Technology, Michigan State University,the Division of Risk, Strategy, and Financial Innovation at the U.S. Securities and Exchange Commission, Rice University, University of Georgia, University of Hawaii, University of California-San Diego,and University of Pennsylvania for valuable comments. We thank IsaacKelly and Joseph Tatefor computational assistance andBret Johnson and Nick Guest for excellent research assistance. Finally, we gratefully acknowledge the financial support of the Marriott School of Management, theFisher College of Business, and the Foster School of Business.
ABSTRACT:
Investors have at their fingertips an almost unlimited supply of financial disclosures. Some of these disclosures are recently released but most have been in the public domain for months oreven years. In this study, we evaluate whether such “stale” disclosures continue to be informative to investors. Using a novel dataset that tracks search requests on the SEC EDGAR database, we find evidence that the acquisition of historical disclosures from EDGAR is positively associated with absolute returns and trading volume within the next two hours. We investigate several potential explanations for why investors might find previously released disclosures informative and find evidence consistent with two explanations: first, investors appear to request historical information in order to provide context for new information releases (e.g., earnings announcements, 8-K filings); second, investors appear to request historical information to resolve cases of high valuation uncertainty. We find noevidence that the relation between requests for historical disclosures and market activity is driven by unsophisticated investors. Our results suggest that financial disclosures continue to remain useful beyond their initial release and highlight the value of historical disclosures and their archives to equity markets.
Key Words: Information Acquisition, EDGAR, Trading Volume
- Introduction
The set of public information available to an investor is vast, diverse and growing. Decades of capital market research provide evidence that the release of new financial disclosures is associated with increased market activity, suggesting that the disclosures are informative.[1] However, new disclosures make up only a very small fraction of the information set available to investors—the overwhelming majority of public information can be consideredhistorical. Given the dominance of old information in the total information set, and the considerable resources required to prepare and maintain financial disclosures, it is important to understand whether historical financial disclosures remain informative to investors. Accordingly, the objectives of this paper are to evaluate the informativeness of historical disclosures and to investigate settings when their informativeness is greatest.
Two factors motivate our research questions. First,in theory, competitive forces quickly drive the net gains from trading on information to zero, thus rendering the information “stale.”[2] Prior research finds that certain types of information can become stale. For example, the evidence in Tetlock [2011] suggests that the redundant articles in the business press are only traded on by unsophisticated investors; these articles provide no new information to rational investors. We examine whether historical (old) financial disclosures retain their informativeness to rational investors (and, if so, why).
Second, there is prior, indirect, evidence that historical disclosures can be informative. For example, there is a large literature on the time-series properties of earnings; the fact that investors employ historical earnings to predict current earnings indirectly suggests that historical earnings are informative for benchmarking (Lev [1983]; Kothari [2001]). Other studies find that information signals based on historical accounting information can be predictive of future returns (e.g., Ou and Penman [1989]; Abarbanell and Bushee [1998]; and Piotroski [2000]). Although the evidence in prior research suggests that historical financial information is informative, that evidence is often a byproduct of a different research question rather than a direct test of the informativeness of historical financial disclosures.
A challenge in addressing the informativeness of historical information is that researchers are generally unable to measure the timing of investors’ acquisition of historical information outside of news release windows. We overcome this measurement problem by using a novel dataset that tracks all investor requests for disclosures on the SEC’s EDGAR database.The dataset records every “click” made by an investor to request a regulated filing, such as a 10-K or 8-K, from EDGAR and thereby provides a direct proxy for investor information acquisition. These data allow us to empirically observe both the timing of investors’ acquisition of previously disclosedfinancial information and the age of the information acquired.Our proxy for historical information acquisition is the number of investor requests for disclosures that have been publicly available on EDGAR for at least 30 days at the time of the request. We make three assumptions regarding these data. First, we assume that if users request a particular company’s disclosure, it is highly likely that they are interested in the information the disclosurecontains about the company; in other words, they consider the disclosure to be potentially informative.Second, given that investorsare acquiring the actual SEC filing, we assume that they are interested in information unique to that filing that cannot be more easily obtained via other financial sources.[3]Finally, although investors can gather financial information from a number of other sources, we assume that investors demand for disclosures is constant across all acquisition channels.
We define informativeness as a temporal association between the acquisition of information and market activity; in doing so, we follow decades of research on the information content of earnings (Kothari [2001]).Note that we are not attempting to establish a causal relation between investor requests and market activity as we do not believe information requests cause investors to trade. Rather, we believe that when investors decide to trade they gather relevant information including financial disclosures (both recent and, possibly, historical). We test the informativeness of historicaldisclosures byexamining the association between investor requests for these disclosuresand subsequent short-termmarket activity,measured as absolute returns and trading volume.We conduct our analysis at the intraday level using hourly requests for disclosureson EDGAR and hourly aggregations of equity market data from the Trade and Quote (TAQ) database. Given the intense computational requirements to analyze intra-day data, we carry out our analyses on a random sample of 200 firms. We account for general news that can influence historical information acquisition by including as controls contemporaneous,absolute stock returns, lagged, absolutestock returns and trading volume, and prior-day returns and turnover.[4](Inclusion of past market activity also controls for the effect of past market activity—which is highly correlated with future market activity—on current requests for disclosures.)
We find thatrequests for historicaldisclosures are positively associated with absolute returns and total trading volume in the subsequent two hours. When we focus on requests for periodic accounting filings(annual reports (10-Ks) and quarterly reports (10-Qs)), ourresults are uniformly stronger than results for all disclosures, underscoring the importance of historical, periodic accountingreports to equity markets. In sensitivity tests, we find that the association between historical disclosure acquisition and market activity holds even during periods of minimal firm-specific news (i.e., after removing periods when firm-specific news, such as earnings announcements, analyst forecasts, and news articles,isreleased), which suggests that these news events are not driving the association. Overall, our evidence is consistent with the notion that historical information is informative to equity markets.
We test three potential reasons for the informativeness of historicalfinancial disclosures. The first explanation is that investors acquire and use old information to provide important context for new information releases and current events. For example, investors may turn to previously filed 10-Ks to assess how managers’ previous discussions of strategic initiatives played out in current periods. We test this notion by examining whether the observed positive association between requests for historical disclosures and subsequent market activity is particularly strong (i.e., more positive) in the presence of two important events,earnings announcements and 8-K filings, while controlling for the normal level of market activity that arises from these events. For earnings announcements, we find that the positive association between requests for historical disclosures and market activitiesis stronger during ashort window around the earnings release. For 8-K filings, we find that the positive association between requests for historical disclosures and market activity is stronger on the date the 8-K is filed. In sum, the evidence is consistent with historical financial information beinginformative to equity markets when acquired and used in conjunction with current information releases.
A second potential reason for the informativeness ofhistorical financial disclosures relates to valuation uncertainty. Our intuition is that valuation is a difficult and subjective process to begin with and is made more difficult and subjective when there is greater uncertainty about the valuation inputs. For certain firms, investors need more time to process and contextualize information,thus investors may continue to find previously filed financial disclosures helpful for valuation assessments. Weusethree different proxies for valuation uncertainty and find that the positive association betweenhistorical information acquisition and market activity is even greaterwhen valuation uncertainty is higher.
The third explanation for the association between historical disclosure acquisition and market activity is based on findings in prior research thatunsophisticated investors acquire and trade on historical information because they are “late to the game”—that is, they access information in an untimely manner and fail to realize that the information is no longer value-relevant. In our empirical model, we follow prior research in assuming thatunsophisticated traders initiatesmaller trades on average (e.g., Frankel et al. [1999]).However, we find that requests for historical disclosures are positively associated with the mean dollar value of individual trades in the subsequent two hours. Thus,the evidence is inconsistent withthe notion that demand for historical disclosures is driven by smaller, less sophisticated investors.[5] Given the difficulty in reading and processing complex financial disclosures such as 10-Ks and our findingthat historical disclosures are used in fundamental analysis, we conjecture that sophisticated investors are more likely to use the information in historical disclosures than unsophisticated investors. Our results are consistent with this conjecture.
Our findings contributeto the emerging literature that investigates whether historical or redundant news is perceived as informative to at least some market participants. For example, Tetlock [2011] and Gilbert et al. [2012] find evidence consistent with individual investors trading on stale (specifically, redundant) news, in the context of media articles and macro-economic indicators. Our paper extends the literature by examining whether a firm’s financial disclosures, which are arguably more prominent, and certainly more regulated and complex than media articles and macro-economic indicators, become stale with age. Given the importance of these disclosures to market participants, examining their informativeness is important in its own right. Another point of contrast between our paper and the Gilbert et al. [2012] and Tetlock [2011] papers is thatthey examine reactions to the release of stale information (i.e., supply), we examine consequences of actual investor requests for stale information (i.e., demand). Finally, we find evidence that old information can be informative to rational investors, which stands in contrast the evidence in prior studies.
In summary, this study revisits an old question of whether disclosures are informative, with an emphasis on historical disclosures. Providing directevidence on this question is important because the vast majority of publicly available information is old. For example, at the start of our sample period (January, 2008), EDGAR hosted over 8.2 million financial disclosures, of which less than 0.2 million (representing 2.5% of all filings)had been in the public domain for less than 30 days and could be reasonably considered“new.” Prior research on the informativeness of financial disclosures hasmostly focused on the release of new information; in contrast this paper is, to our knowledge, the first to directly study the informativeness of historicalfinancial disclosures.
Moreover, our evidence provides insights to regulators, who are concerned about the usefulness of financial information when investors are potentially overloaded by information (Paredes [2008]). The current U.S. regulatory regime requires a broad spectrum of disclosures, from complex, comprehensive period reports (10-Ks, 10-Qs) to small and frequent current disclosures (8-Ks, Form 4s). These disclosures must strike a balance between being so large that investors cannot process their information content quickly and so small that frequent updates are needed. Our findings suggest that historicaldisclosures (especially 10-Ks and 10-Qs) continue to be informative, especially at times of new information releases. We view this as providing some justification forthe substantial costs to firms and regulators of preparing and archiving financial disclosures.
2. The Informativeness of HistoricalInformation
A fundamental step in assessing the informativeness of a disclosure is to test whether investors acquire and use the information contained in that disclosure. Researchers in accounting and finance have long been interested in understanding the role that information acquisition plays in the price discovery process, but have been hampered by the lack of an available proxy for information acquisition. One line of research uses variation in broad firm characteristics such as firm size, analyst following, or institutional ownership to proxy for variation in incentives to acquire information about a particular firm (e.g., Atiase[1985],El-Gazzar [1998], Kirk [2011]). More recent research has begun to examine whether information acquisition can be inferred using different channels of information dissemination, including conference calls (Frankel et al. [1999]), investor conferences (Bushee et al. [2011]), and the media (Soltes [2009], Bushee et al. [2010],Engelberg and Parsons [2011]).
In general, prior researchinfers information acquisition (and thereby informativeness) by examining how disclosure events are associated with differential trading activities by investors before, during and after the event. For example, Frankel et al. [1999] find that capital market activity, such as absolute returns and trading volume, is higher for all measures during conference calls than during the control period. Bushee et al. [2011] find significant short window increases in stock returns and trading volume during managerial presentation at conferences. Busse and Green [2002] and Engelberg et al. [2012] show that information is acquired through media television programs by documenting increases in market activity during and after a stock is mentioned on the shows.
Another stream of research proposes internet search as a more direct measure of information acquisition. For example, Da et al. [2011] find that weekly Google requests for corporate stock ticker symbols are positively associated with contemporaneous weekly abnormal returns and share turnover, while Gao et al. [2011] find that daily Google requests are positively associated with greater trading volume and trade sizes. Drake et al. [2012b] find that Google search requests increase around earnings announcements and provide information that aids in the pricing of earnings news. Thus, the general evidence from studies using Google search as a proxy for information acquisition is that when contemporaneous information is acquired by investors, it leads to increases in trading activities, which suggests that these acquisition events are informative to investors.
Using EDGAR search requests as a measure of information acquisition, we aimto assess the informativeness of historical information. There are several reasons that one would not expect historical financial disclosures to be informative to markets. First, some researchers argue that accounting information lacks timeliness, which in turnreduces its informativeness (Collins et al. [1994]); Ball and Shivakumar [2008]). Older financial disclosures, therefore, may have very little information content remaining months or years after they are made public. Second, there are volumes of macro-, industry-, and firm-specific information available on a more timely basis through other sources (e.g., analysts, the business press, the internet), which reduces the value of historical financial information. Finally, the semi-strongform of the efficient markets hypothesis predicts that the net gains toinformation in disclosures are traded away quickly. This conjecture holds especiallytrue for disclosures that are costless to obtain and widelydisseminated, as is the case with many of the disclosures available on EDGAR.
On the other hand, prior research provides indirect evidence that investors use historical information to provide context for current information (and vice versa), which is consistent with historical information being informative(Freeman and Tse [1989]). In addition, prior research suggests that past information signals can be informative for future returns, which is again consistent with that information being informative. However, we argue that the question of whether and how historical financial disclosures are informative has not been directly addressed in prior research. That is, althoughprior research finds that the acquisition of new information is associated with market activity, such an association has not been tested for historical financial information. This discussion provides the basis for our first hypothesis, stated in the alternativeform: