Chad Larson and Dr. Ted Christensen, School of Accountancy and Information Systems
The Securities and Exchange Commission requires companies to file special reports, called Form 8-K reports, within five to fifteen days of important events that could affect shareholders’ investment decisions. For example, required filings include announcements of events such as mergers and acquisitions, changes in auditors, changes in top management, and other events the filing company deems important to investors. Companies file these reports under nine different item headings. Item Five is the only disclosure that is “optional,” and the nature of Item Five disclosures allows them to contain an array of information and diverse types of information. Electronic copies of all Form 8-K filings are available on the SEC’s website, through the EDGAR (the Electronic Data Gathering, Analysis, and Retrieval) system.
The SEC added more significance to Item Five disclosures on October 23, 2000 by enacting Regulation Full Disclosure (often called Regulation FD). Regulation FD requires companies to disclose to the public any material nonpublic information shared with broker dealers, investment advisers, investment companies, and holders of the company’s securities. Regulation FD is aimed at leveling the playing field for individual investors and professional money managers. The regulation has been highly publicized and the subject of numerous articles in the Wall Street Journal and other business periodicals. Companies fulfill the disclosure requirements in one of two ways: 1) filing a Form 8-K item five disclosure, or 2) filing an item 9 disclosure.
Research Question
Critics of Regulation FD have argued that requiring firms to release information to all market participants at once rather than releasing it first to individual analysts and then to the public would create a poorer information environment, resulting in greater market volatility around earnings announcements. Despite these arguments, recent research by Heflin, Subramanyam and Zhang (2002), concludes that Regulation FD has not resulted in greater earnings volatility or a breakdown in the information environment. Because, prior research has not been able to detect any changes in the information environment pre- or post-Regulation-FD, I attempt to find evidence supporting the other claim made by SEC regulators that the new regulation has helped level the playing field between large and small investors. I endeavor to do this by analyzing 8-K forms. If Regulation FD has truly leveled the playing field for all investors, I would expect to find greater abnormal stock returns around press releases related to Form 8-K item 5 events after the implantation of Regulation FD relative to the pre-FD period. This leads to my hypothesis stated in the null form:
H0: Abnormal stock returns around form 8-K event dates will be equal in the pre- and post-Regulation-FD periods.
Sample Selection
My sample consists of the largest 50 firms on the Compustat database based on total assets (excluding financial services companies). Compustat contains accounting information for most NYSE, NASDAQ, and AMEX companies. I began by collecting and coding all 8-K forms filed from 1999-2001 by these 50 companies. This involved individually hand collecting and coding each form. I collected the forms from the SEC’s EDGAR website. This procedure yielded a final sample of 476 8-K forms, an average of 9.52 forms per company. After collecting the forms, I classified each filing based on the type of disclosure in the 8-K filing. I also coded the SEC filing date and event date. Then using the University of Chicago’s Center for Research on Security Price (CRSP) database, I collected abnormal stock returns for three-day windows centered on each 8-K event date. I calculated abnormal returns as total cumulative returns for firm i minus the average return on the beta portfolio index to which firm i belongs.
Results
Similar to prior research on Regulation FD, I did not find evidence of a significant change in the magnitude of abnormal returns following the enactment of Regulation FD. This result may be biased since my sample selection focused on very large firms. In future research, I may collect a sample of disclosures of smaller firms to investigate whether abnormal stock returns vary systematically following the enactment of Regulation FD for firms where this regulation is most likely to make a difference.1 One additional piece of descriptive evidence I found that supports regulators motives, creation of a richer information environment, is that the number of disclosed 8-K events increased from 11.6 disclosures per month prior to November 2000 to 15.7 disclosures per month after the introduction of Regulation FD.
Future Research
To this point researchers have found very little evidence that Regulation FD has had an effect on the flow of information to capital markets. This result is particularly puzzling considering the large amount of media attention and the large number of complaints surrounding the regulation’s implementation. In addition, anecdotal evidence from stock analysts suggests that the information environment has changed since the adoption of Regulation FD. Analysts report that firm executives are not able to give the specific earnings guidance executives had previously been giving. I hope in the future to conduct a more thorough analysis of whether Regulation FD has had the desired effect of leveling the playing field. A future study could include an analysis of intraday stock trades to see whether the regulation leveled the playing field. Intraday stock data allows the researcher to examine who trades on publicly released information (large or small investors). Overall, even though this project did not yield the results I had anticipated, it has been a valuable learning experience. It has taught me some of the obstacles and difficulties in conducting original research and some additional skills that will be valuable as I further my studies in graduate school beginning next year.
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1 Prior accounting research indicates that abnormal returns around earnings announcements are greater in magnitude for smaller firms relative to larger firms (Atiase, 1985).