Communicating with the Marketplace: Ground Breaking Research by MIT Examines the Relationship between Information Disclosure and a Company's Cost of Capital
Wright, Philip, Phillips, David, European Business Forum
The issue of corporate information--its integrity, scope, distribution, and impact--has become a central business concern in recent years. But despite growing interest in the topic, the link between a company's strategy for communicating with the financial markets and its cost of capital has never been satisfactorily established.
This article drawing heavily on ground-breaking research by Professors S.P. Kothari and Jim Short of MIT--throws new light on that relationship and carries important implications for boardroom executives and their advisers, stock market analysts and representatives of the media. It demonstrates how the credibility and timeliness of information varies according to its source, and concludes that fuller, more transparent and more timely disclosures by companies will directly lower cost of capital and reduce share price volatility.
Disclosure research, it should be pointed out, is an inherently tricky area, requiring the analysis of much qualitative information, as well as quantitative data. The power of the MIT project derives from its innovative method of combining content analysis software with empirical finance research, a combination which enables the analysis of more data over a much longer time period than is possible with traditional techniques. This has therefore given the results a robustness not previously obtainable.
The increased focus on information can be traced to four developments.
* Growing evidence of information failure The fraudulent corporate reporting of some major US and European companies, and the subsequent disgrace of those companies and their senior executives, has drawn a sharp and demanding light onto the topic in both regions. Analysts, commercial and investment banks, auditors, mutual funds, law firms, and securities exchanges have all faced heightened scrutiny and in many cases stiffer regulation. The thread running through much of the enquiry and drive for change has been the quality and equitable distribution of information and the integrity of those who prepare and certify information.
* Globalisation Accounting and reporting regulations have historically been national in jurisdictions. However, in an increasingly global economy, governments, corporate leaders, and investors recognise the need to reach toward what has been called harmonised accounting and reporting standards. Such standards will allow investors in any part of the world to assess confidently the value of a potential investment in any other part of the world, with the certainty that national or regional differences in standards will not lead to the omission of key facts or their presentation in ways that may obscure their importance.
* Conceptual innovations and novel research. Research efforts at the major accounting firms and in the academic world have generated new thinking about the desirable scope of 21st Century accounting and reporting-in effect, about the nature of best practice in a global economy. The message is clear from these sources, whether that message is embodied in PricewaterhouseCoopers' concept of Integrated Reporting and its ValueReporting research (see below) or in the implications of the MIT findings presented here: corporations will better serve investors and achieve greater success by taking an innovative approach to the information they make publicly available.
* Innovations in Technology Technology has also been exerting pressure for change. The increasing adoption of XMRL-based reporting--a system for electronically tagging items of information in such a way that it can be transmitted and analysed with incomparably greater ease than in years past--is changing the expectations of all committed participants in the Corporate Reporting Supply Chain. Investors and analysts expect more information in breadth and depth, better formatted.
Modern finance theory
Over the years, PricewaterhouseCoopers has carried out extensive research into the impact of discretionary, non-mandated disclosure by companies. …