The Precision Effect and Information Content of SFAS No. 95 Disclosures

Abstract:     
This study examines the change in investors' private search activities after being provided SFAS No. 95 disclosures compared with their behavior when provided a set of financial reporting disclosures with APBO No. 19 disclosures. Consistent with the theoretical analysis in McNichols and Trueman (1994), we find that market participants private search behavior changes when provided SFAS No. 95 disclosures. We identify this change as the precision effect associated with SFAS No. 95 disclosures of cash flow from operations. Our research design is similar to that employed in Ball and Brown (1968), yet differs by examining the abnormal returns (i.e., CAR realizations) to good/bad news portfolios formed using earnings and cash flow signals (independently and jointly). We compare the returns across the two reporting enviroments of interest to the study. Also, this study provides initial empirical evidence on price changes associated with unexpected CFO before and after SFAS No. 95 disclosures was mandated and offers a CFO model that closely approximates SFAS No. 95 disclosures for use in periods prior to the implementation of SFAS No. 95. In support of the statements made by financial reporting regualtors, we find that market participants use the information in SFAS No. 95 disclosures with earnings to price securities. However, consistent with the result in Dechow (1994), we find that unexpected earnings dominates unexpected CFO (as measured by association with abnormal returns) when both signals are use to form portfolios.

JEL Classification: G12, D83, M41

working papers series