The Impact of Accounting Disclosures and the Regulatory Environment on the Information Content of Earnings Announcements☆
Introduction
Evidence from cross-country studies indicates that accounting standards, managerial incentives, and the regulatory environment largely determine national-level financial reporting quality (e.g., Ball et al., 2003, Bushman and Piotroski, 2006, Hail and Leuz, 2006, Leuz et al., 2003).1 Mexico provides an interesting setting to examine the usefulness of accounting information following a series of changes to the financial reporting system and corporate governance structure. In this paper, we examine the market reaction to earnings announcements in Mexico following changes to accounting standards and the regulatory environment. Given that prior literature (i.e., Bhattacharya et al., 2000, Prather-Kinsey, 2006) finds no market reaction at the announcement date of annual earnings and other news in Mexico, our study provides evidence on whether these changes have influenced the usefulness of accounting information. More broadly, our study seeks to increase our understanding of how changes in accounting standards, disclosure, and governance influence the behavior of market participants.
Bhattacharya et al. (2000) investigate the short-window market reaction to a variety of news events including dividend, merger, and annual earnings announcements for firms listed on Mexico's primary stock market, the Bolsa Mexicana de Valores (hereafter the Bolsa). Using data from the mid-1990s, they find no market reaction around the announcement date of news events. They conclude that insider trading has incorporated earnings and other news into price before the announcement, and thus there is no market reaction at the announcement date. Prather-Kinsey (2006) focuses on the price reaction to annual earnings announcements for firms listed on the Bolsa from 1998–2000. She finds no evidence of abnormal returns around earnings announcements. Taken together, the results of these studies suggest that the prevalence of insider trading reduces the information content of earnings announcements in Mexico.
However, from 1999 through 2006, Mexican officials implemented several interrelated changes to financial reporting and the regulatory environment. To improve corporate governance, firms were required to increase the percent of independent board members, and the voting capital required to call a meeting decreased from 25% to 10%.2 In addition, financial reporting frequency increased from an annual to a quarterly basis (Familiar Calderón, 2003). Concurrently, regulations compelled firms to file financial reports electronically with the Bolsa. As with the EDGAR system in the United States, electronic reporting allows for timely, low-cost access to financial reports for all investors (World Bank, 2003).
Following the governance changes and increase in reporting frequency, Mexico issued a revised set of accounting standards that were implemented in 2007. The revised standards were designed to converge Mexican GAAP toward IFRS, in preparation for complete adoption of IFRS for publicly-traded companies in 2012 (PricewaterhouseCoopers, 2013). Adoption of IFRS has been shown in prior research to increase financial reporting quality and comparability (i.e., Armstrong et al., 2010, Soderstrom and Sun, 2007).
While Bhattacharya et al. (2000) and Prather-Kinsey (2006) document no market reaction at the announcement date during the 1990s, we hypothesize that changes to accounting standards and the regulatory environment will induce a market reaction to earnings announcements. We examine a sample of earnings announcements from 1998–2011 issued by firms listed on the Bolsa that have the requisite financial and return data in Economatica and analysts' forecasts in I/B/E/S. We partition our sample into three time periods (pre-transition, transition, and post-transition) based on changes in accounting standards and the regulatory environment. To provide a comparison with the results of Prather-Kinsey (2006), we define the pre-transition time period as earnings announcements from 1998–2000. The transition time period covers earnings announcements from 2001–2006 and includes changes to the reporting environment such as electronic filing of quarterly reports and the implementation of the governance code. Finally, the post-transition time period covers earnings announcements from 2007–2011. We hypothesize and find both abnormal returns and abnormal trading volume around earnings announcements in the post-transition period. Consistent with prior research, we do not find evidence of abnormal returns or trading volume in the pre-transition time period.
An important feature of the Mexican securities market is that Mexican firms have the option to issue a variety of classes of equity shares. A-shares are limited to ownership by Mexican nationals, but other aspects such as cash flow and voting rights are the same as B-shares, which can be owned by international investors. When a firm issues only one class of ordinary common equity that fits neither the A nor B designation, these are deemed ORD-shares. Regardless of the class of shares issued, all firms must follow the Mexican GAAP and comply with the listing requirements of the CNBV.3
Bhattacharya et al. (2000) and Prather-Kinsey (2006) use differences in return patterns between A-shares and B-shares to conclude that insider trading eliminates the market reaction to earnings announcements. Therefore, we segment our sample by share class, and hypothesize and find that the market reaction to earnings announcements exists for different share classes in the post-transition time period, but not in the pre-transition time period. The exception is A-shares, which exhibit abnormal volume, but not abnormal returns in the post-transition time period. Overall, these results suggest that in the new reporting environment, earnings are informative to a majority of investor clienteles.
Next, we hypothesize that the market reaction in the post-transition time period is different in the fourth quarter (i.e., annual results) compared to the first through third quarters. Annual earnings announcements are less timely than quarterly earnings announcements, which could lead to a smaller market reaction (e.g., DeFond, Hung, & Trezevant, 2007). Alternatively, market participants could view annual earnings as more reliable and thus more useful for predicting future performance than earnings from other quarters, which could lead to a greater market reaction (e.g., Nicholas and Smith, 1983, Teoh and Wong, 1993). We do not find support for this hypothesis.
We also hypothesize that the market reaction in the post-transition period is different for firms with more transparent information environments. More transparent firms may be more likely to have more frequent and informative disclosures between earnings announcements, thereby reducing the new information in the announcement, resulting in a smaller market reaction (DeFond et al., 2007). Alternatively, more transparent firms might disclose more information in the earnings announcement, resulting in a larger market reaction (Francis, Schipper, & Vincent, 2002). We find that for firms with more transparent information environments, there is a stronger market reaction to bad news earnings announcements, but that transparency is not related to the market reaction to good news earnings announcements.
Our research makes several contributions. First, our study contributes to a larger stream of literature on the capital market consequences of changes in disclosure regimes. Leuz and Wysocki (2008) call for additional research in this area, and suggest that changes in the reporting regimes of developing economies provide interesting research settings given the overall stability in the U.S. reporting regime. Consistent with Ball (2001), our results also imply that isolated changes to the regulatory environment may not be effective in changing behavior of capital market participants. That is, several complementary changes, such as increased disclosure and increased enforcement of disclosure, are necessary to improve capital markets. Our results are consistent with the results of Leuz and Wysocki (2008), who suggest that various features in the regulatory environment in a country complement one another.
We also contribute to a large and growing literature on the information content of earnings announcements in an international setting (i.e., Bhattacharya et al., 2000, DeFond et al., 2007, Landsman et al., 2011, Prather-Kinsey, 2006). Specifically, we examine the market reaction to earnings announcements in a time period following changes to the reporting and regulatory environment in Mexico. To our knowledge, our study is the first to examine the usefulness of accounting information under the new reporting and regulatory environment, and the first to document a market reaction to earnings announcements in Mexico. Thus, our paper contributes to the broader stream of capital market literature about Mexico.
Finally, our finding of a market reaction for all share classes is important to market participants in Mexico. It implies that market efficiency has improved for all investor clienteles. Our findings suggest that the policy changes implemented in Mexico over the past decade are associated with improvements in the capital market.
The remainder of this paper is organized as follows. In section two we discuss the institutional features of Mexico, review the literature, and formulate hypotheses. In Section 3 we discuss our research design and sample selection, and Section 4 presents our main empirical findings. Robustness tests comprise Section 5, and we conclude in Section 6.
Section snippets
Literature review and hypothesis development
Mexico is an export-oriented, developing economy (e.g., Kirkwood, 2000). The North American Free Trade Agreement (NAFTA) of 1994 continued to reduce barriers to international trade. While currency devaluation crises were regular occurrences in the latter half of the 20th century, Mexico has not experienced a currency crisis since the mid-1990s. In fact, by 2003, inflation rates were low and stable in Mexico (Kose, Meredith, & Towe, 2004). The legal tradition, restrictions on equity ownership,
Research design — univariate tests
Tests of our hypotheses require proxies for information content. As in prior research, we conduct our univariate tests based on two common measures of information content: abnormal stock returns and abnormal trading volume. Specifically, we follow Prather-Kinsey (2006) and compute the daily and cumulative abnormal return (CAR) around the earnings announcement date for each security.8
Empirical results
We present descriptive statistics for our sample in Table 1 for both security-quarter observations and firm-quarter observations.20 We provide a breakdown of observations by year and further
Robustness tests
We examine the robustness of our results to several different specifications of our univariate measures and regression models. Our first set of robustness tests involves alternative estimations for abnormal returns. First, we measure the market return, Rmt, using an equal weighted return of all firms on the Bolsa that trade on day t, as opposed to the IPC index. Second, as in Prather-Kinsey (2006) we estimate our market model parameters using the method developed by Scholes and Williams (1977)
Conclusion
In this paper, we examine how changes in accounting standards and the regulatory environment influence the usefulness of accounting information in Mexico. To conduct our analyses, we partition our sample into three time periods: pre-transition (1998–2000), transition (2001–2006), and post-transition (2007–2011), based on changes in accounting standards and the regulatory environment. We hypothesize and find that the market reacts to earnings announcements in the post-transition period.
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We thank two anonymous reviewers, editor A. Rashad Abdel-khalik, coeditor Ehsan Feroz, Brian Burnett, Leslie B. Fletcher, Roger Graham, Dave Guenther, Hsiao-Tang Hsu, Steve Matsunaga, Timothy Shields, participants at the 2012 AAA Western Region Meeting, the 2012 AAA Annual Meeting, the 2013 International Accounting Section Midyear Meeting, the 2013 Southern California Accounting Research Forum, and workshop attendees at California Polytechnic University, San Luis Obispo, for their helpful comments. All errors and omissions are our own.