Firm Performance and Management's Discussion and Analysis Disclosures: An Industry Approach

Abstract

Over the period 1993-2001, this study examines whether the disclosure practices in the Management's Discussion and Analysis (MD&A) section and Part I of the annual report for 71 firms in four diverse industries (banking, airlines, pharmaceuticals and electronics manufacturing) are differentially associated with the firm's future operating performance and valuation. Supplemental to the financial statements, the Securities and Exchange Commission (SEC) asserts that MD&A disclosures should provide investors and other users with transparent information on the financial condition and results of operations of the registrant, with particular emphasis on the registrant's prospects for the future. Our study addresses this issue. We find that our disclosure index based on comprehensive content analysis provides incremental explanatory power in predicting future firm performance and market valuation while controlling for current income and other related factors. While previous studies have not considered differential industry analyses, our results vary by the nature of the industry, particularly when future performance is more closely related to nonfinancial performance measures that are generally not disclosed or not clearly disclosed in current MD&A and Part I of the annual report information. This suggests that the SEC's current concern for more meaningful analysis in MD&A disclosures might well be more expressly directed to specific industries, e.g., the banking and pharmaceutical industries in our sample. Finally our evidence also suggests that the market assigns a higher market value to firms that are upfront with investors. In short, transparency - in terms of providing disclosures associated with current and future firm performance - pays as even though there is a differential industry effect, the market seems to reward firms that provide investors with the critical information they need to value their investments.

Keywords: Disclosure, Firm Performance, Market Valuation