Academic journal article Journal of Legal, Ethical and Regulatory Issues

The Effects of Legal Environment on Voluntary Earnings Forecasts in the U.S. versus Canada

Academic journal article Journal of Legal, Ethical and Regulatory Issues

The Effects of Legal Environment on Voluntary Earnings Forecasts in the U.S. versus Canada

Article excerpt

ABSTRACT

Past research documents managers' reluctance to issue voluntary earnings forecasts in part due to legal considerations. Since Canadian laws create a less litigious environment than those of the U.S., this study finds that when the two environments are compared, Canadian managers issue voluntary earnings forecasts more frequently across the board. In addition, the Canadian forecasts tend to be more precise than those of their American counterparts.

INTRODUCTION

Prior research in the study of voluntary earnings disclosures finds that managers release information that is unbiased relative to subsequently revealed earnings and that tends to contain more bad news than good news [Baginski et al.(1994), and Frankel (1995)]. Such releases are also found to contain information content [Patell (1976), Waymire (1984), and Pownell and Waymire (1989)]. Although forecast release is costly, credible disclosure will occur if sufficient incentives exist. These incentives include bringing investor/manager expectations in line [Ajinkya and Gift (1984)], removing the need for expensive sources of additional information [Diamond (1985)], reducing the cost of capital to the firm [Diamond and Verrechia (1987)], and reducing potential lawsuits [Lees (1981)].

More recently, studies show that managers are more likely to issue voluntary forecasts in a less litigious environment [Frost (2001)], [Johnson et al, (2002], while another [Baginski et al. (2002)] indicates that there are legal environment differences between the U.S. and Canada in issuing earnings forecasts when smaller size firms are evaluated. My research extends the aforementioned studies by evaluating U.S. and Canadian firms of all sizes and over a more extended period. The research question becomes: Do Canadian firms issue voluntary earnings forecasts with greater regularity than U.S. firms and which forecasts exhibit greater accuracy?

Clarkson and Simunic (1994) note that unlike the U.S., courts in Canada generally require unsuccessful plaintiffs to pay the costs of a successful defendant. Also, because plaintiffs have no absolute right to a jury trial in Canada, judges hear technical cases and are less likely to award large settlements. In addition, Canadian provinces do not permit trial lawyers to work on a contingency basis. Also, it is much more difficult to bring a class action suit in Canada. All of these differences in the legal systems create a natural environment in which voluntary earnings releases may be perceived differently.

HYPOTHESIS DEVELOPMENT

Three hypotheses are tested. First, King et al (1990) finds that forward-looking information disclosure in the U.S. increases the firm's exposure to legal liability. It is, in part, for this reason that many U.S. firms have exhibited a reluctance to issue voluntary forecasts on a consistent and ongoing basis. The first hypothesis, stated in the alternative form is:

H1: Canadian firms, faced with a less-litigious legal environment, engage in more voluntary earnings forecasts relative to U.S. firms.

The second hypothesis, also stated in the alternative form, relates to previous studies that indicate U.S. firms are less likely to issue voluntary forecasts during good news periods for fear of litigation:

H2: Canadian firms, faced with a less-litigious legal environment, engage in voluntary forecast releases that are less-related to earnings than U.S. firms.

The third hypothesis, stated in the alternative form, centers around the notion that as voluntary forecast are made with greater frequency, they also tend to exhibit greater accuracy over the long term:

H3: Canadian firms engage in more precise forecasting of earnings information.

RESEARCH DESIGN

The sample consists of all quarterly and annual estimates made during the period 1983-2003 meeting the following criteria: 1) The voluntary earnings forecast was recorded by the Dow Jones News Retrieval Service (DJNRS). …

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