Why Firms Voluntarily Disclose Bad News Douglas J. Skinner Journal of Accounting Research, Vol. 32, No. 1 (Spring, 1994), 38-60. Stable URL: fip:flinks jstor-org/sic sici-0021-8456%28 19942129323. 1%3C38%IA WEVDBN%IE2.0.CO®3B2-4 Journal of Accounting Research is currently published by The Instcute of Professional Accounting, Graduate Schoo! of Business, University of Chicago. Your use of the ISTOR archive indicates your acceptance of [STOR's Terms and Conditions of Use, available at tlp//ewvejstororglabouttenms.html. ISTOR's Terms and Conditions of Use provides, in pat, chat unless you fave obtained pcior permission, you may not dowaload an cnt isus of @ journal or multiple copies of articles, and you may use content inthe ISTOR archive only for your personal, non-commercial uss. Please contact the publisher cegarding any further use of this work. Publisher contact information may be obtained at bup:orww stor org/joummals/grad-uchicago.hen, Each copy of any part of a JSTOR transi printed page of such transtnission. ion must contain the same copyright notice that appears on the screen or ISTOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding ISTOR, please contact support @jstor.org- hup:therwwjstor.orgy ‘Tue May 25 00:49:38 2004ourmal of accountag Resear iat aN Tsar inet Prat SE Why Firms Voluntarily Disclose Bad News DOUGLAS J. SKINNER* J. Introduction This paper provides evidence on corporate voluntary disclosure practices through an examination af the earnings-related disclosures made by a random sample of 98 NASDAQ firms during 1981-90." [find that, consistent with prior studies, earnings-related voluntary disclo- sures occur infrequently (on average, one disclosure for every ten quarterly earnings announcements); good news disclosures tend to be point or range estimates of annual earnings-per-share (EPS), while bad news disclosures cend to be qualitative statements about the current quarter's earnings; the (unconditional) stock price response to bad University of Michigan [thank J. Abarbanell, A. Alford, J: Anthony, M. Beth, Bernard, M Beadley,D. Collins, H. DeAngelo, L DeAngelo, N. Dopuch, M. fokason, P. O'Brien, V. O'Briex, K.Palepu, R Sloan, A. Suceney, C. Waymire, workshop partic panty at Harvard University, the Universi of Towa, the University af Michigan, Michigan Seste Univers, che Thira Conference on Finacial Economics and Accounting ot New York Univecnity the University of Notee Dame, the Ohio State University, Purdue Us serscy, Washingvon Usiversiy in St Louis, and Yale Universiy, nd especially evo anon mous referees for helpful comments on previous versions, ad Li Li Eng and Michael Mosebach fer research assistance. I aso appreciate comments by J. Caper Alexander, J. Newer, J Seligman, and G.Siedel that helped me with the legal analyse the pape Financial sapport from the KPMG Peat Marwick Foundation is gratefully acknowledged. am respon for any remaining errors 9¢ amnion Te earehed the Dow Jones Nous Retrieval Serie fr all statemneacs chat are atibueable a the company oF its officials and thae convey information 2bout the Eem’s earaigs prospects. This earch yielded point forecasts, range farecats, and wpper- and lower bound forecasts, 24 well a8 qualitative statements about furure ceraings, Duclosures that ‘elated ta either annual and/or quacterly earnings wert included, 3 ‘Capmigno iamtue of Froeasona! Accounting: 224WHY FIRMS VOLUNTARILY BISCLOSE BAD NewS 39 news disclosures is larger than the response to good news disclosures; quarterly earnings announcements that convey large negative earnings surprises are preempted about 25% of the time by voluntary corporate disclosures while other earnings announcements are preempted less than 10% of the time. Overall, the evidence is consistent with the idea chat managers face an asymmetric loss function jn choosing their voluntary disclosure pol icies—managers behave as if they bear large costs when investors are surprised by large negative earnings news, but not when other earnings news is announced. There are at Jeast wo reasons managers may bear costs as 2 result of large negative earnings surprises. First, stockholders may sue when there are large stock price declines om earnings an- nouncement days, since stockholders can allege that managers failed (0 disclose adverse earnings news promptly. Managers can be held per- sonally liable in auch suits, and their activities may he disrupted by hav- ing to deal with this litigation. Second, managers may incur reputational costs if they fail to disclose bad news in a timely manner. Maney managers, stockhalders, security analysts, and other investors dislike adverse earnings surprises, and may impose costs on firms whose managers are less than candid about potential earnings problems, For example, money managers may choose not to hold the stocks of firms whose managers have a reputa- tion for withholding bad news and analysts may choose not to follow these firms’ stocks. These costs will affect managers’ disclosure deci- sions as long as managers have an incentive to maintain the level of heir firm’s stock price through some (unspecified) mechanism.” Not all che sample disclosures about earnings convey bad news, and. these other disclosures appear similar to those evaluated in previous work, That is, they are typically point or range estimates of annual EPS that generally convey either little information or good news (sce Lev and Penman {1990] and Pownall, Wasley, and Waymire [1993] for ex- ceptions). My evidence suggests thac by limiting cheir samples (0 point or range forecasts of annual EPS, some previous papers appear co have excluded an important subset of all voluntary disclosures, specifically qualitative disclosures that. preempt the information in quarterly earn- ings releases The next section of the paper lays out why securities laws may mod vate managers to preempt bad quarterly earnings news. Section $ sum- marizes existing accounting research on discretionary disclosure, and section 4 details the research hypotheses. Section 5 describes the sample * Recent analyical research suggests that managers disclose bad news to deter enc! competition in their frm’ product markers (eg, see Daraugh and Scoughuon (1990) and Newnan and Sansing [1893]} or to goal their “qualiy” (Teoh and Hrsg (199 (]} However, ic seems unlikely that the exeningsrelated bad news disclosures in this sudy are driven by these incentives.