Decheng Feng
Ifrah Zubaid-Ahmad
Jinnie Sahota
Julie Wong
Information Approach
 Information approach: the equating of usefulness to
information content
 The investors want to make their own predictions of
future security returns (instead of having accountants
do it for them, as under the real conditions)
 Assuming securities market efficiency, recognizing that
the market will react to useful information from any
source, including financial statements
Reasons for Market Response
 Prior beliefs about a firm’s future performance
 Upon release of net income, some investors
will become more informed
 Increase/ decrease of purchase
 Fluctuate of the volume of shares
Beaver
A well-known study examined
trading volume reaction
Dramatic increase in volume
during the week of earnings
announcements
Factors to Consider
 Efficient markets theory
 Narrow window of a few days surrounding the date of
news release
 Good/bad news evaluated relative to what investors
expected
 Must obtain a proxy of what investors expected net
income to be
 Many events take place that affect a firm’s share
volume & price
 Hard to predict which reaction is correlate to which
event
Separating Market-Wide and Firm-Specific
Security Returns Using the Market Model
Estimate Beta ≠Actual Beta
1. Second opinion on beta from FS
2. Compares the before and after the
announcement period to estimate beta
3. Ignore beta
Estimate Beta ≠Actual Beta
Ignore beta


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Difference between firm stock return period 0 and the
average return on its shares over some prior period
Difference between firm return during period 0 and
the return on the market portfolio for the same period
Total shares returns and not factor out market wide
return at all
Ball and Brown Study (1968)
 First to provide convincing scientific evidence
 Firms’ share returns respond to the
information content of financial statements
 Event study
 Examined a sample of 261 NYSE firms for over 9
years
 Only concentrate on earnings
Ball and Brown Study…
 Greater than market had expected (GN)
 Less than market had expected (BN)
 Proxy: last year earnings
 Last year earnings < GN
 Last year earnings > BN
Recap
The conclusion from observation of narrow window?
Answer: Accounting information is the cause of the
market reaction
Recap
What is the conclusion wide window (11 months)
observation?
Answer: In an efficient market, security prices reflect all
available information, not just accounting information.
Therefore net income and returns are associated but is not
the caused the abnormal return
Market & Information
 Market responds differently to good/bad
news in earnings for some firms but not
others
 Learning why will help to:
 Improve understanding of usefulness to
investors
 Prepare more useful FS
 BB Study helped to explain differential
market response to earnings information
Earnings Response Co-efficient
Measures the extent of a security’s
abnormal market return in
response to the unexpected
component of reported earnings of
the firm issuing that security
Reasons for Differential Market Response
 BETA
 Capital Structure
 Earnings Quality
 Indirect Approach – Infer earnings
 Earnings Persistence
 Accruals Quality
 Growth Opportunities
 Similarity of Investor Expectations
 Informativeness of Price
Implications ERC Research
 Reasons why accountants should be interested in the
markets response to financial accounting information
 Suggests ways we can improve with the use of
disclosures
 Examples:


Informativeness of price – lower for smaller firms means that
expanded disclosures for these firms would be useful to
investors
ERC lower for highly levered firms - means that expanded
disclosure re: financial instruments
Disclosure of Environmental
Information
 Most disclosure goes beyond
requirements
 Environmental reporting
choices
 Impact interpretation of firms
financial performance
 Unusual that information is not credible
 Avoid : Enhance environmental
management
Impact of Disclosures
• Careful determination of
disclosures
• Manage public opinion and
perception
• Media influences public opinion
about environmental issues
• Some institutions provide a
disclosure frame of reference in
most countries as firms imitate
one another
Advantages/Disadvantages
• Handbook Sec.3060
• Mandated the disclosure and recognition
into financial statement of future site
removal and related costs
• Disclosing potentially damaging
information
• Advantages with expanded disclosure
• Increased consideration of risks/factors
• Disadvantages with disclosing too much
• Apprehension among Investors
Looking to the Future
• Canadian companies leverage their
environmental disclosure strategy through an
internet
• Print disclosure and web disclosure is extensive
overlap
• Web-based disclosure viewed as extension of
traditional print disclosure
Recap
Why do firm incur cost to disclose environmental
information?
Answer: They want to reduce information gap, and
this helps investors gain confidence in the firm
Recap
Does it matter?
Answer: Yes, because when investors are confident then
the firm benefits by:
 Lowering its cost of capital
 Raising it stock valuation multipliers
 Increasing stock liquidity
 Enhancing interest by institutional investors
However to be credible, the information needs to be
some what critical about the firm’s firm environmental
management
Value Creation
 Benefits Maximization
 Promising Investments
 Identification of non-financial
performance indicators
 Managing and communicating cost
effectively
Value Creation in Biotechnolgy
 Non-financial information is critical
 Fast growing due to:
 Positive clinical data
 Upbeat medical conferences
 Drug approvals
 Not always financial
Better Signals
 Non-financial information:
 Better predicts future earnings trends
 And catches:


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Improvements in products
Operating processes
Strategic alliances
Disclosure Strategy
 What to disclose:
 How to disclose:
 Market penetration
 MD&A – annual reports
 Floor space of retail
 Report to shareholders
stores
 Press releases
 R&D
 Website
 Number of hits on
 Filings
website
 Financial analysts
 What to consider:
 Timing, security laws and
ethics
Biotechnology Basis
• Healthcare
• Agriculture
• Food
• Environment
• Defense
• Rapidly growing
– Products under development
– Alliances
– Press releases
Biotechnology Value Creation
 Influences:
R&D

Quality drugs

Clinical trials

Linked phases
2. Government approval

Launch
3. Strategic alliances

Ability to market
1.
Non-Financial Disclosures
 Time consuming processes
 Long time before earnings realized
 Market value driven by hope (not PV)
 Non-financial fills lag
Strengthening Hope
 Disclosure of drug development stages:
1. Completion of clinical trials
2. +/- results for different phases
3. Government approval and patents
4. Alliances
5. Product launch
Positive Reactions
 Non-financial vs. financial
 Non-financial s more timely
 Phase III commencement
 Results of Phase II and III
 FDA approval (this is key)
 R&D alliances
 Final stage: government approval
Emerging Industries
 Three strategic alliances
 R&D alliance most important
 Sets foundation
 Industry specific disclosures
 What drives value?
 Non-financial information vs.
 Financial information
Recap
When is non-financial information more
informative than financial ?
Hangman
Time!
Hint: This is one of the influences in creating
value for the firm
Answer: Alliances
Hint: This is one of the most important nonfinancial disclosure in Biotech industry
Answer: FDA approvals
Any Questions?
Thank you for Listening