When and How is Voluntary Disclosure Quality Reflected in Equity Prices?

Abstract:     
This paper investigates whether and when voluntary disclosure quality (VDQ) is priced in equity valuations. The assumption one makes regarding the speed with which security prices incorporate information has important implications for the appropriate method to study this question. For example, several papers have asked whether VDQ matters more for firms with little information otherwise available, positing that VDQ allows these firms to lower cost of equity. But it is for these firms that implied cost of capital estimates are unlikely to be very informative. We instead use a portfolio-based approach. If VDQ is net beneficial for shareholders, among opaque firms we expect that those with higher VDQ will see their future stock price go up, when investors realize and price the benefits of VDQ. Thus, higher VDQ is predicted to be associated with higher excess returns for such companies. A key novel feature of our empirical analysis is that we study the role of VDQ for one market consisting of firms with widely varying degrees of information processing speed. We find that in a sample of firms about which much is known in the market, VDQ is not a priced risk factor and does not contribute to explaining variation in realized returns. By contrast, for a sample of relatively opaque firms (such as those with few analysts), where we do not expect equity prices to immediately incorporate all available information, risk-adjusted excess returns of firms with high VDQ are indeed higher than those with low VDQ. Moreover, for these firms, higher VDQ is associated with stronger operating performance. Among various potential sources of this empirical regularity, the most plausible explanation overall appears to be that for these opaque firms VDQ can generate value, for example, through facilitating better investment decisions.

Number of Pages in PDF File: 45

Keywords: Voluntary disclosure quality, portfolio analysis, value reporting, disclosure

JEL Classification: G11, G14, G30, M41

working papers series