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

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 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

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 & 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 Identification of non-financial performance indicators Managing and communicating cost effectively Benefits Maximization Promising Investments

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: Improvements in products Operating processes Strategic alliances

Disclosure Strategy What to disclose: Market penetration Floor space of retail stores R&D Number of hits on website How to disclose: MD&A – annual reports Report to shareholders Press releases Website Filings 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: 1. R&D Quality drugs Clinical trials Linked phases 2. Government approval Launch 3. Strategic alliances Ability to market

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 non- financial disclosure in Biotech industry Answer: FDA approvals

Any Questions?

Thank you for Listening