Essays on the Effect of Mandatory Changes in Corporate Transparency: Evidence from Segment Reporting


Student thesis: Doctoral Thesis

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Award date18 Jan 2021


There is an ever-growing interest among regulatory agencies and practitioners in firms’ segment reporting. For example, segment reporting ranks as the fourth common areas in SEC comment letters regarding companies’ 10-K reports issued in 2017 and 2018 (Ernst & Young, 2018). The SEC even settled a lawsuit with truck and engine maker Paccar Inc. over “accounting deficiencies” or transparency regarding its segment reporting in 2013. The U.S. Financial Accounting Standard Board (FASB) is considering revising the current segment reporting requirements and has one finished and one on-going project that seeks input from public companies to test the operability of various potential changes to the transparency in segment reporting. At the same time, many activist investors are continually requesting increase in corporate transparency especially for firms whose operations straddle multiple industries and geographies sometimes with threats of corporate raids.

Despite the increasing interest in firms’ segment reporting, whether and how segment reporting could affect the market for corporate control is an under-studied topic. Chapter 1 of this thesis which is a collaborative work by myself, Dr. SUN Teng Stephen, and Dr. ZHANG Zilong sheds light on this question by exploiting the most recent change in segment reporting from SFAS No.14 to SFAS No.131 in 1997, which increased segment reporting transparency for multi-segment firms. The results show firms increasing segment reporting transparency due to SFAS 131 are more likely to receive a takeover bid. Consistent with the increased transparency in segment reporting lowering information risk, such an effect is more salient for firms with ex-ante inferior financial reporting quality. The results do not support the potential higher proprietary cost or improved governance channels. Based on the examination of all initiated takeover bids, results show that bids for affected target firms are more likely to be completed and take shorter time to complete. Other deal outcomes are also consistent with acquirers’ belief of lower information risk in the affected target firms. Lastly, deals involving targets who increased transparency of their reported segments due to SFAS 131 adoption are perceived as quality deals by the market, i.e. positive abnormal returns around the announcement.

The SFAS 14 to SFAS 131 regulatory change mandatorily increased transparency in financial reporting for multi-segment firms. Transparency in financial reporting mitigates information asymmetry between inside and outside investors by lowering insiders’ information advantage and improving outsiders’ assessment and valuation of future firm performance. Based on this conventional wisdom, increased transparency due to SFAS 131 is expected to lower profitability of insider trades. However, a mandatory increase in corporate transparency potentially crowds out private information production thereby increasing the profitability of insiders’ trades. Chapter 2 of this thesis exploits this setting to provide evidence consistent with causal interpretations for these arguments and predictions. The results show that increasing transparency in segment reporting due to SFAS 131 lowered insiders’ trade profitability. Consistent with the information channel, such an effect is concentrated among firms with ex-ante higher information asymmetry and higher investors’ uncertainty. Results do not support alternative interpretations such as the governance and proprietary cost mechanisms.

A summary of the two studies highlighting the research objectives and questions as well as an overall conclusion is presented in Chapter 3 of this thesis.