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Accounting Research Center, Booth School of Business, University of Chicago Cross-Sectional Determinants of Analyst Ratings of Corporate Disclosures Author(s): Mark Lang and Russell Lundholm Source: Journal of Accounting Research, Vol. 31, No. 2 (Autumn, 1993), pp. 246-271 Published by: Blackwell Publishing on behalf of Accounting Research Center, Booth School of Business, University of Chicago Stable URL: http://www.jstor.org/stable/2491273 . Accessed: 02/05/2011 01:30 Your use of the JSTOR ar
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  Accounting Research Center, Booth School of Business, University of Chicago Cross-Sectional Determinants of Analyst Ratings of Corporate DisclosuresAuthor(s): Mark Lang and Russell LundholmSource: Journal of Accounting Research, Vol. 31, No. 2 (Autumn, 1993), pp. 246-271Published by: Blackwell Publishing on behalf of Accounting Research Center, Booth School of Business,University of Chicago Stable URL: http://www.jstor.org/stable/2491273. Accessed: 02/05/2011 01:30 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and youmay use content in the JSTOR archive only for your personal, non-commercial use.Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at . http://www.jstor.org/action/showPublisher?publisherCode=black . . Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printedpage of such transmission.JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new formsof scholarship. For more information about JSTOR, please contact support@jstor.org.  Blackwell Publishing and  Accounting Research Center, Booth School of Business, University of Chicago arecollaborating with JSTOR to digitize, preserve and extend access to  Journal of Accounting Research. http://www.jstor.org  Journal of Accounting ResearchVol. 31 No. 2 Autumn 1993PrintedinU.S.A. Cross-Sectional DetermninantsofAnalyst RatingsofCorporate Disclosures MARKLANG* AND RUSSELL LUNDHOLMt 1.Introduction Inthis paper we examine cross-sectional variationinanalysts' pub-lishedevaluationsof firms'disclosurepracticesandprovideevidencethat the analysts'ratingsareincreasing in firmsizeand infirmperfor-mance as measuredby earningsand returnvariables, decreasing inthecorrelation betweenearningsandreturns,andhigherfor firmsissuingsecuritiesin thecurrent or futureperiod.Results basedon the volatil-ity of past performance aremixed.WhiletheSEC'smandatorydisclosurerequirements provideabasicframework and minimum standard formanyfinancialdisclosures,con-siderable latitude remainsindetermining whatinformation isactuallyprovided.Some firms' annual andquarterly reports gowellbeyondtherequired disclosures,while others areextremelystark. Less formalcom-municationchannels, such as press releases and direct contact withanalysts,allow even more discretion. This widerangeofdisclosurealter-natives isaggregatedby analystsintheReports of theFinancialAnalysts *StanfordUniversity;tUniversityofMichigan.We thankA.Alford,B.Beaver,S. Bon-ner, J. Hughes,B.Johnson, W. Landsman,F.Lindahl, M. McNichols,F.Selto,W.Shaw,S.Teoh,P.Wilson, J.Wahlen,ananonymous referee, theparticipantsat the 1991Uni-versityof IowaSidneyG. Winter LecturesSeries,andworkshop participantsat StanfordUniversity,theUniversityof NorthCarolina,DukeUniversity,theUniversityofTexas,theUniversityofColorado,theUniversityofCalifornia atLosAngeles,theUniversityofMinnesota, HarvardUniversity,andtheAmericanAccountingAssociation for theirhelp-fulcomments,andLynch,Jones&Ryanforprovidingtheanalystforecast data.246 Copyright (?,Institute of ProfessionalAccounting1993  DETERMINANTSOF ANALYST RATINGS 247FederationCorporatenformationCommittee FAFReports) o provide an over-all measure of corporate communicationswith investors. A typical year'sreport provides a detailed analysisof disclosure practices for about 27 in-dustries, with an average of 17 firms evaluated by an average of 13 ana-lystsineach industry, summarizedwith ratingsinthree categories:annualpublished information, quarterlyand otherpublishedinforma-tion,and investor relations.To explain the analysts' ratings offirmdisclosure, weconsider vari-ables suggested by existing researchonvoluntarydisclosure.'Theoret-ical research provides severalmotivations for disclosure -overcomingadverse selection, reducingtransactioncosts in themarket,and reduc-ing expected legal costs by preemptinglarge negative stock pricere-sponsestoearningsannouncements-which yield predictions aboutthe relationbetween disclosure and variousfirmcharacteristics,in-cluding performance,information asymmetry between investors andmanagers,incentivesforprivateinformationacquisition, legal expo-sure, propensityto accesscapitalmarkets,anddisclosure costs.Much oftheempiricalresearchondisclosure focusesonmanage-mentearningsforecasts andgenerallyfinds that thefrequencyof suchforecastsishigherforlargefirms,firms with less volatileearnings,and firms issuing securities. Evidenceonthe relation betweenthe fre-quencyofmanagementforecastsand firms'earningsand stockpriceperformanceis mixed.While management earningsforecastsreportedinthe financial press are concrete and measurable, they representonlyone ofmany corporatedisclosures. In contrast,the FAF dataprovideamorecomprehensivemeasurethat includes bothquantifiableandnonquantifiable aspectsof disclosure.Inaddition,theFAFratingsarebasedontheperceptionsofanalysts, arguablytheprimaryusers offinancial disclosures.2 A disadvantage of theFAFdatais thattheyarebasedonanalysts' perceptionsof disclosureratherthandirect mea-sures of actual disclosure.Other researchwhich focusesonperceptionsof firms' disclosuresincludesSutley [1992],who finds that winnersofthe Financial Post'sannualreportaward have smallerearnings responsecoefficientsand 1Inchoosingvariables from thevoluntarydisclosure literature, we assume thatanalystratingsmeasure disclosure informativeness. The FAFReport suggests this, statingthat theanalysts attempttomeasure the firm's effectivenessincommunicatingwith investors and the extent to whichinformationisprovided sothat investorshave the informationnecessarytomake informed judgments, using all disclosures by the firm,bothqualita-tiveandquantitative. However,because theanalyst ratings maybeaffectedbyotherfac-tors,care shouldbe exercisedininterpretingtheempiricalresults.Thisissueisdiscussed in moredetailinsection3.2Inaddition,because themanagementearningsforecast literaturefocuses on an-nouncements in thefinancial press, cross-sectionalcomparisons of disclosure are poten-tiallyconfoundedbyeditorialbias;certaintypesof firms orannouncementsmaybemorelikelyto becoveredinthe financialpress.  248 JOURNAL OF ACCOUNTING RESEARCH, AUTUMN 1993smaller return-earnings correlations thannonwinners.Inaddition,Imhoff[1992] surveys analysts andprovides evidence that their per-ceptionsof accounting quality areincreasinginthepredictabilityofearnings,firmsize,andthe stabilityof the relationbetween earningsand sales, and decreasinginthe likelihood of a bad news annual earn-ings announcement and thedebt-to-equityratio.UsingthesurveydatafromImhoff[1992] and the overalldisclosure scores from theFAFRe-ports,Imhoff and Thomas[1989]find that firms withhigh-qualityrat-ings by analyststendto use moreconservative accounting practicesandhave higherFAFdisclosurescores,but thatfirmprofitabilityis theonlyvariable related to both conservativeaccounting practicesand disclo-sure scores.3In the next sectionwe discussthe relationbetweendisclosurechoices and firmcharacteristics.Thenwe discussthe FAF data in moredetail; finally, we present the empiricalanalysis, interpretationsof theresults, and conclusions. 2.Literature Review andMotivation Becauseafirm's disclosure decisions are influencedbyavarietyof considerations, we structure our empiricalanalysisbased on asurveyofthe theoretical andempirical literaturesrather thanrelyingonanyparticularmodel.Weconsider sixpotential explanatoryvariablesgrouped for convenience into threecategories-performance variables(returnsandanalyst forecast errors),structural variables (firm size,re-turnvariability,and the correlationbetween annual returnsand earn-ings),and theoffer variable (theextenttowhichthefirmis active inissuing securities).Theperformancevariablesare timeperiod specific,representinginformation towhichmanagement mayhavepreferentialaccess andwhich is likely to be thesubjectofdisclosureduringthepe-riod. Thestructuralvariablesmeasurefirmcharacteristics that arewidelyknownandlikelyto remainrelativelystable over time. The offervariable does not fitneatlyinto eithergroup-securities offeringsaretimeperiod specific,but firmswhichoffer securitiesgenerallydo so re-peatedly,andsecurityissuance is a choice variable for the firm.2.1 DISCLOSURE AND FIRMPERFORMANCE Theperceptionthatfirms' willingness to disclose informationis re-lated to theirperformanceiswidespread,but the directionoftherela-tion is not clear.Underlying manyofthe SEC's deliberationsand thediscussioninexchange listingguides,forexample,isa concern thatmanagementwill tendto be moreforthcomingwhenthefirmisper- 3Other studies of disclosure, which have used researcher-created disclosure indexes,mostly predate the development of voluntary disclosure theory and are primarily de-scriptive. See Ball and Foster [1982] for a summary.
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