Michael Tam, Brenda Bell, Andrea Marchlewicz,
Henry Ly and Shaun Young
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Market Response Research
Ball and Brown
Earning Response Co-Efficient
Best Accounting Policy
Value Creation in the Biotech Industry
Does Disclosure Matter
Conclusion
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Rational investors in an efficient market make
their own predictions as to the value of firms
and accounting is used to provide information
for this purpose
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Information is deemed useful if it changes the
investors’ beliefs, which will cause a market
response.
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Investors have prior beliefs on firm value
Rational investors will seek out new
information to revise their beliefs
They will buy or sell shares based on their
new beliefs
Volume of traded shares will increase and
share price will change
Beaver study
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Tests for changes in share price due to
information
Timing of information release
 Earnings
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Good News (GN) or Bad News (BN)
 Based on prior expectations of investors
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Other factors of share price
 Market-wide vs Firm-specific returns
 Rjt = αj + βjRMt + Єjt
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Market response study as outlined
Used prior year Net Income as the
expectation
Done using monthly returns because that was
the best data available at the time
Results: Good News associated with positive
abnormal returns and vice versa
Repeated with a wide window
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Brown and Ball Theory
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http://www.youtube.com/watch?v=_QDBX9
KfxHM
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Basis of future research
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Beaver, Clarke, and Wright
 The greater the magnitude of the unexpected
earnings, the greater the magnitude of the price
change
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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A security’s abnormal market return in
response to the unexpected portion of
reported earnings
ERC =
Abnormal share return
Unexpected earnings for the period
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Beta
Capital Structure
Earnings Quality
 Earnings persistence
 Accruals quality
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Growth Opportunities
Similarity of investor expectations
Informativeness of price
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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To gauge market response to information
Separate persistent and non persistent
information
 Extraordinary items
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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In theory the “best” policy is to maximize ERC
 Useful information with increase ERC
 Firms should disclose all useful information
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Other considerations
 Public vs Private goods
 Cost vs Benefit
 Impact beyond the corporation and investors
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Public Good: consumption by one person
doesn’t prevent its use by another (e.g. roads)
Private Good: consumption by one person
prevents its use by another (e.g. an apple)
What would you consider accounting
information to be? A private or public
good?
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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This can cause inequality between supplying
the “right” amount of information versus the
benefits investors gain from the information
Does maximization of ERC benefit society?
 Cost-benefit trade-off between the company,
investors, and the public
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Accounting standard setters must beware of
using market responses to create their
accounting policies
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Inconclusive evidence as to the usefulness of
other financial statement information
Difficult to study
 More timely sources of this information
 Difficult to pinpoint release of information
 Information is released simultaneously
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Indirect approach:
 Impact of GN or BN on the ERC
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12 “fundamentals” by Lev and Thiagarajan
used to evaluate earnings quality
Concluded that non earnings information
explains abnormal returns not from earnings
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
Bruce McConomy; Bixia Xu
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Biotechnology : creates innovative products and technology by applying
living organisms to different science fields
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Rise of biotechnology: Canada 2010 valued at $86.5 billion
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Areas of biotechnical firms:
 Health Care
 Food & Agriculture
 Intellectual Property
 Industrial & Environmental
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Article focus: Biotech health care firms
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Purpose: to develop and produce drugs
 Products under development, generally not for sale—NOT
your typical pharmaceutical company
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New value chain
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
Supporting Activities:
Company
Information Systems
Infrastructure
Procurement
Human Resource
Financing
Mgmt
Primary Activities:
Inbound logistics
Operations
Outbound
logistics
Marketing
& sales
Service
Supporting Activities:
Intellectual Property Protection (Legal)
Facilities (Contract Research Organization)
Procurement (Contract Manufacturers)
Human Resources Management
Information Systems
Strategy
Financing
Investor Relations
Primary Activities: R&D
Pre-Clinical
Trial
Investigational
New Drug Stage
Phase I
Clinical Trial
Phase II
Clinical Trial
Phase III
Clinical Trial
FDA Final
Approval
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Three main contributors of the biotech value chain
 R&D
 Compliance with government regulations; government
approval
 Strategic alliances
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Question: based on what you know about decision
theory and the development of products in the
biotech sector, what is the useful information needed
by investors when re-evaluating their future
expectations of a biotechnical firm?
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles

Drug development is a substantially long process,
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value creation can take a long time to be realized in earnings
 Non-financial disclosure is extremely important
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Disclosure becomes more important as you near the end of the research
and development cycle
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R&D is a better measure of future firm performance than is the reported
earnings
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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The lag between a biotech’s stock price and the accounting system can
be resolved by disclosing non-financial performance
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Such disclosures include:
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Report to shareholders
 Press releases
 Web site disclosures
 Regulatory filings
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Managers in the biotech industry have greater reason to manage
disclosure
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles

QUESTION: Non-financial disclosures are
important in forming future expectations of
investors; however, what could be the negative
implications of disclosing this information?
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Earnings, and other financial statement figures, are not the
only factors in shaping the expectations of investors
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The lag between revenue recognition in earnings can be
solved with non-financial statement disclosure.
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The importance of disclosing the successes and failures
during the R&D process can be carried over to the other
areas of the biotechnical industry
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
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Self Regulation Versus Standards
Section 3061- High Quality of Information
Is the Information provided Relevant?
Does this information provide value to a firm?
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
Articles
Manager
Standard
Setters
Shareholders
Based on your point of View:
Is Environmental Standards required and what specifically
should be required?
What are your goals for Financial Statements?
Will this result in a Benefit to Society?
Managers
Standard Setters
Stakeholders
•Can bring a lower
cost of capital
•Enhance interest by
Institutional Investors
•Increased
Transparency
•Consistency
Across Companies
•Integration into
financial reporting
•Increased
Transparency
•Provides credible
information
•Keeps companies
held responsible
•Reduces potential
risk
Disadvantages of •Costly
Disclosure
•Will hurt the
reputation of the
company
•Risk of credibility
with partial disclosure
•Can be costly to
society
•Must balance the
cost versus benefit
Advantages of
Disclosure
1.
2.
3.
Expanded management discussion and
environmental analysis
A revision of reporting under some
uncertainty
Increased Auditor consideration of
environmental risk
Market
Research
Brown
and Ball
Earning
Response
Best
Policy
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