Decheng FengIfrah Zubaid-AhmadJinnie SahotaJulie 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 FS2. Compares the before and after the

announcement period to estimate beta3. Ignore beta

Ignore beta 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

Estimate Beta ≠Actual Beta

Ball and Brown Study (1968)First to provide convincing scientific

evidenceFirms’ 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

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

Recap

Market & InformationMarket responds differently to

good/bad news in earnings for some firms but not others

Learning why will help to: Improve understanding of

usefulness to investorsPrepare 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 StructureEarnings Quality

Indirect Approach – Infer earnings

Earnings Persistence Accruals Quality

Growth OpportunitiesSimilarity of Investor

ExpectationsInformativeness 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 disclosuresExamples:

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 credibleAvoid : 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

RecapWhy do firm incur cost to disclose environmental information?

Answer: They want to reduce information gap, and this helps investors gain confidence in the firm

RecapDoes 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

Identification of non-financial performance indicators

Managing and communicating cost effectively

Benefits Maximization

Promising Investments

Value Creation in BiotechnolgyNon-financial information is

critical

Fast growing due to:Positive clinical dataUpbeat medical conferencesDrug approvals

Not always financial

Better Signals

Non-financial information:

Better predicts future earnings trends

And catches: Improvements in products Operating processes Strategic alliances

Disclosure StrategyWhat to disclose:

Market penetrationFloor space of retail

storesR&DNumber of hits on

website

How to disclose:MD&A – annual reportsReport to shareholdersPress releasesWebsiteFilingsFinancial 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 CreationInfluences:

1. R&D Quality drugs Clinical trials Linked phases

2. Government approval Launch

3. Strategic alliances Ability to market

Non-Financial Disclosures

Time consuming processesLong time before earnings realizedMarket value driven by hope (not PV)Non-financial fills lag

Strengthening HopeDisclosure of drug development stages:

1. Completion of clinical trials2. +/- results for different phases3. Government approval and patents4. Alliances 5. Product launch

Positive ReactionsNon-financial vs. financialNon-financial s more timely

Phase III commencementResults of Phase II and IIIFDA approval (this is key)R&D alliances

Final stage: government approval

Emerging IndustriesThree strategic alliances

R&D alliance most importantSets foundation

Industry specific disclosuresWhat 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 non-financial disclosure in Biotech industry

Answer: FDA approvals

Any Questions?

Thank you for Listening