Market Effects of Recognition and Disclosure

Market Effects of Recognition and Disclosure
Author: Mary E. Barth
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Total Pages: 44
Release: 2010
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Our recognition and disclosure model reveals that accounting expertise acquisition and three informational forces, the quality of the recognized amount, the quality of disclosed information, and the quality of information revealed by price, have offsetting and countervailing effects on market performance. It also reveals that recognition of an accounting amount potentially alters each of these forces and expertise acquisition, thereby affecting market performance. We find that recognition of a highly unreliable accounting amount, rather than simply disclosing it, can result in greater price informativeness. Likewise, recognition of a highly reliable amount can result in lower price informativeness. Our findings suggest that basing recognition decisions on reliability alone is too simplistic: reliability relative to relevance is key, not reliability per se. We also find that recognition and disclosure affect the coefficients in a regression of price on accounting amounts, even when the relevance and reliability of the accounting amounts are the same.

Does Recognition Versus Disclosure Matter?

Does Recognition Versus Disclosure Matter?
Author: Kun Yu
Publisher:
Total Pages: 436
Release: 2009
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Abstract: An important area of research and issue of interest for standard setters is whether information disclosure in the footnotes is a substitute for recognition in the financial statements. SFAS 158, issued in 2006, requires the recognition of pension liabilities that were only disclosed in the footnotes under SFAS 87, for the fiscal year ending after Dec. 15, 2006. I empirically examine whether the recognition of the previously disclosed off-balance-sheet pension liabilities affects investors' valuation and firms' contracting costs. I also incorporate levels of investor sophistication in my analyses. Using a sample of firms with pension liabilities that were disclosed under SFAS 87 and subsequently recognized under SFAS 158 from 1999 to 2007, I find that, without considering investor sophistication, SFAS 158 generally does not increase the value relevance of the previously disclosed off-balance-sheet pension liabilities. However, after taking into account investor sophistication, I show that the disclosed off-balance-sheet pension liabilities are more value relevant for firms with a higher level of investor sophistication in the pre-158 period; more importantly, I find that SFAS 158 significantly increases the value relevance of the previously disclosed off-balance-sheet pension liabilities for firms with a low proportion of sophisticated investors, and the increase in the value relevance is less pronounced for firms with a higher proportion of sophisticated investors. Consistent with the contracting theory, I find that requiring the recognition of previously only-disclosed liabilities affects the debt contracting cost and the cost of capital. However, only sophisticated investors appear to understand the effect of SFAS 158 on the debt contracting cost and the stock price. Overall, the results support that recognition affects investors' valuation and firms' contracting costs. The results also highlight the role of the level of investor sophistication in the value relevance of disclosed vs. recognized financial information.

The Impact of Recognition Versus Disclosure on Financial Information

The Impact of Recognition Versus Disclosure on Financial Information
Author: Shana Clor-Proell
Publisher:
Total Pages:
Release: 2014
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We investigate whether recognition on the face of the financial statements versus disclosure in the footnotes influences the amount that financial managers report for a contingent liability. Using an experiment with corporate controllers and chief financial officers, we find that financial managers in public companies expend more cognitive effort and exhibit less strategic bias under recognition than disclosure. This difference appears to be associated with capital market pressures experienced by public company managers as we find that both the cognitive effort and bias exhibited by private company managers are unaffected by placement. As a result, public company managers make higher liability estimates for recognized versus disclosed liabilities. Their liability estimates are similar to those of private company managers for recognition but lower than private company managers' estimates for disclosure. Our results have implications for auditors and financial statement users in evaluating recognized versus disclosed information for public and private companies.

The Economic Consequences of Recognition Versus Disclosure

The Economic Consequences of Recognition Versus Disclosure
Author: Preeti Choudhary
Publisher:
Total Pages: 48
Release: 2012
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I examine how recognition versus disclosure of the fair value of stock compensation affects the compensation decision (the amount and structure of options awarded). The median firm in my sample disclosed fair value option costs equal to about 7% of profits in 1996 and 11% of profits in 2004. When fair value option costs are recognized, I find an average (median) reduction in option grants equal to 9% (0.4%) of absolute net income. The evidence indicates that firms substituted options with restricted stock during fair value recognition; however, I find no evidence of changes in option grants during the fair value disclosure pronouncement. These results suggest that managers and governing boards treat recognition differently from disclosure, such that the inclusion of fair values in summary total figures leads to systematic changes in the structure of contracts, while changes in the valuation method do not lead to such changes.

Recognition Versus Disclosure

Recognition Versus Disclosure
Author: Doron Israeli
Publisher:
Total Pages: 59
Release: 2015
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The application of International Accounting Standard (IAS) 40, Investment Property, in the European Union created a unique setting to study the implications of a decision to recognize versus disclose financial statements' items because in this setting recognized and disclosed investment-property-related amounts share a common measurement base, i.e., fair value. I utilize this setting to (1) explore factors associated with a firm's choice to recognize versus disclose fair values of investment properties, (2) test whether recognized and disclosed amounts are valued equally by equity investors, and (3) determine whether these amounts exhibit equivalent associations with future financial outcomes. To correct for self-selection concerns and assure I compare analogous amounts, I develop a selection model and construct investment-property-related amounts that differ only in whether their components are recognized or disclosed. I find that (1) contractual and asset pricing incentives help explain the recognition versus disclosure choice, (2) investors place smaller valuation weights on disclosed amounts, and (3) recognized and disclosed amounts exhibit statistically equivalent associations with future changes in net rental income and cash flows from operations. Taken together, the evidence suggests that managers are opportunistic in making the recognition versus disclosure choice and that even when recognized and disclosed amounts share an equivalent measurement base and are equally relevant for future financial outcomes, investors weight disclosed information less heavily in determining a firm's value.

Disclosure Versus Recognition

Disclosure Versus Recognition
Author: Jeremy Michels
Publisher:
Total Pages: 55
Release: 2016
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Standard setters explicitly state that disclosure should not substitute for recognition in financial reports. Consistent with this directive, prior research shows that investors find recognized values more pertinent than disclosed values. However, it remains unclear whether reporting items are recognized because they are more relevant for investing decisions, or whether requiring recognition itself prompts differing behavior on the part of firms and investors. Using the setting of subsequent events, I identify the differential effect of requiring disclosure versus recognition in a setting where the accounting treatment of an item is exogenously determined. For comparable events, I find a stronger initial market response for firms required to recognize relative to firms that must disclose, although the large magnitude of the identified effect calls into question whether this difference can be attributed to accounting treatments alone. In examining various reasons for the stronger market response to recognized values, I fail to find support for the hypothesis that this difference is due to differential reliability of disclosed and recognized values. I do find some evidence that investors underreact to disclosed events, consistent with investors incurring higher processing costs when using disclosed information.

Disclosure Versus Recognition

Disclosure Versus Recognition
Author: Julie Cotter
Publisher:
Total Pages: 32
Release: 2003
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Australian GAAP requires firms to either disclose or recognize the current values of real estate in their financial statements. Given recognition criteria related to reliable measurement, the propensity to recognize an upward revaluation is subject to the inherent uncertainty of the assessed increase in value. Accordingly, we predict and find that managers are more likely to recognize (rather than just disclose) revaluations when the revaluation estimate is more reliable. The recognition criteria contained in Australian GAAP implies that market participants will rationally infer that revaluations recognized in the balance sheet are more reliably measured than those disclosed in footnotes. An analysis of share market effects finds that the market discounts disclosure compared to recognition of real estate revaluations. This effect becomes insignificant when controls for the reliability of revaluations are included in the analysis, and we therefore conclude that the value relevance of recognized revaluations is not due to recognition per se, but rather to the fact that the assets being revalued are more reliably measured.

Does Recognition Versus Disclosure Affect Debt Contract Design? Evidence from SFAS 158

Does Recognition Versus Disclosure Affect Debt Contract Design? Evidence from SFAS 158
Author: John Donovan
Publisher:
Total Pages: 49
Release: 2019
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We study how recognition versus disclosure affects the control function of accounting through the use of debt covenants. While research shows that recognition affects the value-relevance of reported amounts, the effect on contracting is unclear. We examine whether covenants changed around SFAS 158 adoption, which required recognition of previously disclosed pension liabilities. We find that pension underfunding is negatively associated with the use of capital (i.e., balance sheet) covenants prior to recognition. Post-SFAS 158, pension underfunding is associated with a higher likelihood of using capital covenants relative to the pre-period. We find no evidence that SFAS 158 alters the use of income statement covenants. Additional analysis suggests a decrease in cost of debt with no corresponding change in credit risk. Collectively, the evidence suggests that recognition enables more effective allocation of control through the use of covenants because financial statements better represent the financial condition of the borrower.