We investigate whether information transparency at the industry level is associated with the sustainability of within-industry differences in profitability. Since competition leads to the elimination of intra-industry profitability differences, this investigation provides evidence on whether competitors act on information about rivals. Using an industry-level transparency measure that integrates corporate reporting by firm managers, private information search and communication by analysts, and information dissemination by the media, we find that transparency is associated with faster reductions in within-industry profitability differences. Using aggregate financial statement data for public and private firms provided by the U.S. Census Bureau, we further find that differences in profitability between public and private firms are less persistent when public firms’ profitability exceeds private firms’ profitability, consistent with theoretical and anecdotal arguments that public firms are at a competitive disadvantage because they are required to be more transparent than private counterparts. Our results are robust to the use of local newspaper closures and mergers as exogenous shocks to transparency. Collectively, these findings indicate that information transparency facilitates competition, leading to the erosion of profitability differences within an industry. We further demonstrate that information transparency is positively associated with the degree to which competitors enter or exit an industry in anticipation of changes in the industry’s profitability outlook.
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We use NAICS codes because the data from the U.S. Census Bureau that we use for additional analysis relies on the NAICS codes. Our results are robust to the use of two-digit SIC codes.
Stigler (1963) and Qualls (1974) argue that highly concentrated industries experience a slower mean convergence of profitability. Similar effects apply to R&D and advertising investment, which create potential innovations and product loyalty (Roberts 1999; Bunch and Smiley 1992). Additionally, employees’ skill level represents industry complexity, one of the main informational impediments to imitation (Mansfield et al. 1981; Lippman and Rumelt 1982; Mansfield 1985; Dierickx and Cool 1989). On the other hand, the number of firms and capital intensity are normally treated as factors that expedite the convergence process, because they possibly increase competition and the efficiency of capital utilization (Waring 1996).
Mas-Colell (1998) points to perfect knowledge and market transparency as key assumptions to reach market equilibrium (p. 18). Stiglitz (1985) argues that “when one of the central pieces (the assumption of perfect information) is removed, the structure [of perfect market competition] collapses” (p. 26). Salop (1976) and Stiglitz (1989) argue that imperfect information can contribute to market power, which works against perfectly competitive outcomes. In particular, Salop (1976) argues, “because imperfect [and costly] information gives firms market power at least in the short run and often in the long run as well ... the relevant market structure with imperfect information is not perfect competition but rather [close to] monopolistic competition” (p. 240). Allen (2014) points to the fact that producers undergo costly information searches to underscore the economic importance of information for product market competition.
“Conceptually, DQ differs from existing disclosure measures in that it captures the “fineness” of data and is based on a comprehensive set of accounting line items in annual reports” (Chen et al. 2015, p.1019).
Forecasts of long-term earnings growth provide crucial forward-looking and value-relevant information (Da and Warachka 2011).
“With weekday circulation of about six million copies, these four newspapers account for 11% of total daily circulation in the United States” (Fang and Peress 2009, p. 2027).
We restrict this search to firms ranked in the top 20% of sales for the industry each year, which allows us to sample economically significant portions of each industry while economizing on labor-intensive searches. In addition, to ensure the accuracy of our news search, as suggested by the Factiva representatives, we further narrow the results to news articles in which the leading paragraph contains the full company name and the word count is greater than 50.
To ensure reasonable estimates of ROA and its components, we require each firm to have at least $10 million in revenue.
Our sample period starts from 1981 because it’s “the first year in which I/B/E/S consistently provides analysts’ forecasts of long-term earnings growth” (Dechow et al. 2000, p.13).
The QFR program collects and publishes quarterly aggregate statistics on the financial results and position of U.S. corporations in specific industries. The data can be found on the Census website: https://www.census.gov/econ/qfr/historic.html. The QFR target population consists of all corporations engaged primarily in manufacturing with total assets of $250,000 or more and all corporations engaged primarily in mining, wholesale trade, retail trade, information, or professional and technical services (except legal services) industries with total assets of $50 million or more. QFR uses a mail-out/mail-back survey to the selected firms. Nearly all corporations whose operations are within scope of the QFR and have total assets of $250 million or more are included in the sample pool, and random samples are selected from the eligible units in the remaining strata. The average response rate of the whole sample is higher than 60%, with greater response rates from larger firms. The QFR survey is conducted on a calendar quarter basis. Companies report their financial data for each of their fiscal quarters and are included in the calculation of the calendar quarter estimates of QFR depending on the month their books are closed. To merge the Compustat data with the QFR database, we first translate the historical NAICS code of each company to the 2007 NAICS code by using concordances of NAICS provided by the Census Bureau. We then translate the 2007 NAICS code to the QFR industry classification using a mapping between the two provided by the QFR program.
A recent survey by the Readership Institute of Northwestern University shows that local papers have much higher local readership than other papers. In 2006, 71% of respondents read a local paper, whereas 24% read a paper other than (or in addition to) a local paper.
The average percentage of newspaper reduction for the industry captures both the average percentage of newspaper reduction for individual firms within the industry and the proportion of firms that experienced such newspaper reductions. For example, the 1% reduction in newspaper coverage for the industry can be due to 100% of firms within the industry experiencing a 1% reduction in their newspaper coverage, 1% of firms within the industry experiencing a 100% reduction in newspaper coverage, or everything else between these two extremes.
Statistics of U.S. Businesses (SUSB) Employment Change Data Tables are available through the following link: https://www.census.gov/programs-surveys/susb/data/tables.2016.html
For example, a new set of firms could emerge as the most and least profitable with the exactly the same profit differential as the most and least profitable firms from the previous year.
We find that the correlation between industry-year earnings persistence and FERC is insignificant. Thus, the relation between FERC and the persistence of within-industry profitability differences is unlikely to be mechanical.
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Feng, R.(., Kimbrough, M.D. & Wei, S. The role of information transparency in the product market: an examination of the sustainability of profitability differences. Rev Account Stud (2021). https://doi.org/10.1007/s11142-021-09626-4
- Information transparency
- Profitability convergence
- Proprietary costs
- Earnings persistence
- Product market competition
- Abnormal profits