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Effect of information disclosure and transparency ranking system on mispricing of accruals of Taiwanese firms

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Abstract

This paper examines whether disclosure transparency, as measured by the rankings of “Information Disclosure and Transparency Ranking System” (IDTRS) constructed by Taiwan Securities and Futures Commission in 2003, reduces accrual anomaly and is useful particularly for sophisticated investors in valuing stocks using accruals. The preliminary results indicate that firms with high rankings show a limited reduction in overpricing of accruals and cash flow and lower abnormal returns, relative to firms with low rankings in disclosure transparency. Given more disclosure, firms with more sophisticated institutional shareholders exhibit significantly lower mispricing of accruals and future abnormal returns. However, after controlling for confounding factors influencing stock returns, we find no evidence that accruals predict abnormal returns. Taken together, the findings suggest that IDTRS is useful in reducing mispricing of accruals for sophisticated investors, but the disclosure effect of the IDTRS may not be considerable enough to exhibit substantial benefit from disclosure on mitigating the mispricing of accruals. The evidence provides policy implications to the regulatory authority in developing a mechanism to lessen the information asymmetry problem.

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Notes

  1. Taiwan Stock Exchange Corporation (“TSEC”) and the Gre Tai Securities Market entrusted Taiwan Securities and Futures Institute to launched IDTRS in 2003.

  2. Increasing disclosure quality of a firm’s future cash flow directly reduces the assessed co-variances with other firms’ cash flow and indirectly influences a firm’s real decisions, and thus affects cost of capital and reduces non-diversifiable risks (estimation risk) (Lambert et al. 2006).

  3. 98 % (96 %) of companies inquired about the results, of which 38 % (41 %) of companies appealed to the TSFI before public announcement in 2011 and 2012.

  4. DeBoskey and Gillett (2013) find that the cost of debt is positively related to disclosure information transparency, while the cost of equity is positively related to intermediary information transparency and insider information transparency.

  5. In particular, managers voluntarily disclose information in the following situations: capital market transactions, corporate control contests, stock compensation, litigation, proprietary costs, and management talent, and signaling.

  6. The level of voluntary disclosure is positively associated with cost of equity capital for firms with a low analyst following and no relation for firms with a high analyst following (Botosan 1997). Increased disclosure also reduces investors’ risk in estimating their return from investment in stocks and requires a lower level of risk premium (Klein and Bawa 1976; Barry and Brown 1985; Coles and Loewenstein 1988; Handa and Linn 1993; Coles et al. 1995; Clarkson et al. 1996).

  7. Using experimental study, Bloomfield and Wilks (2000) find that higher disclosure quality induces investors who have less uncertainty in their payoff to buy stocks at higher prices, which increases liquidity for firms, particularly when there are unexpected demand shocks facing the investors.

  8. Dopuch et al. (2012) find that the degree of accrual mispricing is lesser for loss firms, due to their less relevant negative earnings.

  9. Extending the accrual anomaly to an international setting, Thomas (2000) finds that the market cannot correctly incorporate foreign earnings’ persistence into the stock price, and thus a trading strategy based on the underestimated persistence of foreign earnings can yield positive abnormal returns. Pincus et al. (2007) find four (Australia, Canada, UK, and US) out of twenty countries present accrual mispricing and document that the mispricing is associated with a country’s accounting and institutional factors. Those countries with common law, diversified stock shares, and more prevalent accrual accounting are likely to have accrual anomaly.

  10. For example, Liang et al. (2012) find that the decision of voluntary disclosure, as measured by conference call, is positively related to the ownership of foreign institutional investors in the Taiwan stock market.

  11. If the persistence of cash flow for firms with low rankings is overvalued, than the coefficient of CF is negative i.e. ω 4 < 0.

  12. Following Collins et al. (2003), we ranked firms’ institutional holdings and let top one-third as high ownership and bottom one-third as low ownership for firms with high level of disclosure transparency.

  13. The purpose of this system is to strengthen corporate governance in disclosure transparency, rather than provide an overall evaluation of the information quality, as follows: (1) develop a set of evaluation criteria corresponding to local market demand in order to promote the disclosure transparency of business information and harmonize with international practices, (2) improve disclosure transparency to reduce firms’ cost of capital and increase firm value, (3) provide investors with a decision aid for better protection of investors’ rights, and (4) serve as a reference for regulatory authority and expedite sound development of capital market.

  14. According to the Taiwan Securities and Exchange Act, Rule 36, No. 1, all listed and over-the-counter companies must announce financial reports and submit to the regulatory authority by the end of April following fiscal year. This rule was amended on 2010, November 24, in which the 4-month period is reduced to 3 months following each fiscal year.

  15. Collins et al. (2003) use the holdings that listed firms have to report to U.S. Securities and Exchange Commission to calculate the institutional ownership. They then utilize Bushee’s (1998) three categories of institutions with different trading strategies and focus on the transient institutional investors’ behavior. The transient institutional investors are most likely to lessen the mispricing of accruals and benefit from it as they respond to information more quickly and trade more frequently. As there is no available data to identify investors’ attribute, we can only calculate institutional holdings as stated above.

  16. The untabulated results of regressing future returns on ranked accrual, ranked cash flow, size, and book-to-market shows the same conclusion.

  17. The results, which are not tabulated, of regressing future returns on ranked accrual, ranked cash flow, size, and book-to-market, and institutional holdings reveal the same conclusion.

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Acknowledgments

Correspondence: Hua Lee. The authors are grateful for the editor and the anonymous reviewer for their valuable comments. The comments from the reviewers, discussants, and participants at 2012 American Accounting Association Annual Meeting in Washington, D.C. and 2011 Accounting Theory and Practice Conference in Taipei, Taiwan, are appreciated. Hsien-Li Lee thanks the Conference Grant from National Science Council, Taiwan (No. 101-2914-I-033-013-A1).

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  1. Department of Accounting, Chung Yuan Christian University, 200 Chung Pi Road, Chung Li, Taiwan

    Hsien-Li Lee

  2. Department of Accounting, Hong Kong Shue Yan University, 10 Wai Tsui Crescent, North Point, Hong Kong

    Hua Lee

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  1. Hsien-Li Lee
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Correspondence to Hua Lee.

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Lee, HL., Lee, H. Effect of information disclosure and transparency ranking system on mispricing of accruals of Taiwanese firms. Rev Quant Finan Acc 44, 445–471 (2015). https://doi.org/10.1007/s11156-013-0413-5

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