l'H'ES'S LIBRARY big] Midligfln State A! ' University , This is to certify that the dissertation entitled REAL TIME DISLCOSURE THROUGH CURRENT REPORTS: THE CASE OF MATERIAL CONTRACTS presented by EDWARD XUEJUN Ll has been accepted towards fulfillment of the requirements for the Doctoral degree in Accounting and Information System K N J Major Professor's Signature Li. 323108“ Date MSU is an affinnative-action, equal-opportunity employer -.—._._i—.-— inn—v...-.—._.-—.-.-.-.—.—._.-uv PLACE IN RETURN BOX to remove this checkout from your record. TO AVOID FINES return on or before date due. MAY BE RECALLED with earlier due date if requested. DATE DUE DATE DUE DATE DUE 5/08 KlProj/Acc8Pres/ClRC/Dale0ue.indd REAL TIME DISCLOSURE THROUGH CURRENT REPORTS: THE CASE OF MATERIAL CONTRACTS By Edward Xuejun Li A DISSERTATION Submitted to Michigan State University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY Department of Accounting and Information Studies 2008 ABSTRACT REAL TIME DISLCOSURE THROUGH CURRENT REPORTS: THE CASE OF MATERIAL CONTRACTS By Edward Xuejun Li I examine the determinants and capital market implications of choosing current reports over other SEC reports to timely disclose an important set of non-routine corporate events—material contracts. My evidence suggests that firms with relatively less informative routine disclosures and higher market uncertainty choose current reports. Recognizing the multi-dimensional nature of competitive costs, I find that firms also choose current reports when facing lower (higher) competition from incumbents (potential entrants). From a capital market standpoint, firms choosing timely current reports have a lower level of information asymmetry and a 135 basis point lower annual cost of capital. Dedicated to my parents, J i Li and Renmei Zhang, and my host family in Lansing, John and Bonnie Bankson, for their love and support. iii ACKNOWLEDGEMENTS I thank the members of my dissertation committee for their invaluable instruction and guidance: Marilyn Johnson, Ranjani Krishnan, K. Ramesh (Chair), and Jeffrey Wooldridge. In particular, Ramesh deserves my deepest gratitude for being such an inspiring and caring mentor. I am also indebted to the other faculty members in the Department of Accounting and Information System and my Ph.D. student colleagues for their support and encouragement. I acknowledge the comments from and discussions with Anwer Ahmed, Joseph Anthony, Sudipta Basu, Aloke Ghosh, Zhaoyang Gu, Bin Ke, Robert Lipe, Carol Marquardt, Mary Lea McAnally, Kathy Petroni, Grace Pownall, Eric Press, Min Shen, Clifford Smith, Wayne Thomas, Senyo Tse, Joseph Weber, Hal White, Alexander Woods, Joanna Wu, Yong Yu, Stephen Zeff, Jerry Zimmerman, and workshop participants at Baruch College, Carnegie Mellon University, Emory University, Michigan State University, Pennsylvania State University, Temple University, Texas A&M University, the University of Oklahoma and the University of Rochester. I gratefully acknowledge the financial support provided by Michigan State University through a Dissertation Completion Fellowship. I also thank Limin Wang and Yun Zhou for their assistance with PERL programs. Mark Brod of Simpson Thacher & Bartlett LLP and Jeffrey Minton of the US. Securities and Exchange Commission provided useful inputs on SEC regulations. Professor Stephen Brown generously provided the PIN measure used in this dissertation. TABLE OF CONTENTS LIST OF FIGURES .......................................................................................................... vii LIST OF TABLES ........................................................................................................... viii CHAPTER 1: INTRODUCTION ........................................................................................ 1 CHAPTER II: PRIOR RESEARCH AND HYPOTHESIS DEVELOPMENT ................. 8 2.1 Prior Research ........................................................................................................... 8 2.2 Firms’ Incentive to Use Form 8-K as the Disclosure Channel for Material Contracts ....................................................................................................................... 10 2.2.1 Earnings Informativeness, Sophisticated Market Participants and Form 8-K Disclosure of Material Contracts .............................................................................. 10 2.2.2 Changes in Capital Structure, Mergers and Acquisitions and Form 8-K Disclosure of Material Contracts .............................................................................. 12 2.2.3 Product Substitutability, Entry Costs and Form 8-K Disclosure of Material Contracts ................................................................................................................... 13 2.3 Disclosure of Material Contracts through Form 8-K and Information Asymmetry .................................................................................................................... 15 2.4 Impact of the Increased Regulatory Costs in the Post-Regulation Period .............. 17 CHAPTER III: RESEARCH DESIGH ............................................................................. 19 3.1 Identifying and Extracting Information from Material Contracts ........................... 19 3.2 Development of Models .......................................................................................... 20 CHAPTER IV: SAMPLE SELECTION AND DESCRIPTIVE EVIDENCE ON MATERIAL CONTRACTS DISCLOSURE ................................................................... 25 4.1 Sample Selection ..................................................................................................... 25 4.2 Descriptive Evidence on Material Contracts Disclosure ........................................ 26 CHAPTER V: HYPOTHESIS TESTS ............................................................................. 30 5.1 Descriptive Statistics ............................................................................................... 30 5.2 Determinants of Choosing Form 8-K over Other SEC Reports ............................. 32 5.3 Capital Market Implications of Choosing Form 8-K over Other SEC Reports ...... 35 CHAPTER VI: CONSEQUENCES OF THE 2004 REGULATORY CHANGE ............ 38 CHAPTER VII: DISCLOSURE MEDIUM CHOICE VERSUS REDACTION IN MATERIAL CONTRACTS ............................................................................................. 40 CHAPTER VIII: CONLCUDING REMARKS ................................................................ 42 APPENDICES .................................................................................................................. 66 Appendix A: Material Contracts Disclosure and Form 8-K Regulation ....................... 67 A. 1 Material Contracts Disclosure ............................................................................ 68 A2 The 2004 Regulatory Change ............................................................................ 69 Appendix B: Steps to Identify Material Contracts ........................................................ 72 Appendix C: Steps to Extract Information from Material Contracts ............................ 74 Appendix D: Definition of Variables ............................................................................ 79 BIBLIOGRAPHY ............................................................................................................. 96 vi LIST OF FIGURES Figure 1(a): Distribution of Material Contract Event Dates ............................................. 44 Figure 1(b): Distribution of Material Contract Disclosure Dates ..................................... 45 Figure 2: Cumulative Distribution of Material Contract Disclosure Lag by Disclosure Media ................................................................................................................................ 46 vii LIST OF TABLES Table 1: Descriptive Information on Firms’ Material Contracts Disclosure through Form 8-K ........................................................................................................................... 47 Table 2: Descriptive Information on Form 8-K Disclosure of Material Contracts by Contract Types .................................................................................................................. 48 Table 3: Descriptive Statistics .......................................................................................... 49 Table 4: Correlation Matrix .............................................................................................. 50 Table 5: Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure ......................................................................................................... 52 Table 6: Capital Market Implications of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure ..................................................................................... 54 Table 7: Descriptive Information on Form 8-K Disclosure of Material Contracts after the 2004 Regulatory Change ............................................................................................. 56 Table 8: Determinants and Capital Market Implications of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure after the 2004 Regulatory Change .............................................................................................................................. 57 Table 9: Disclosure Medium Choice and Redaction Decision for Material Contracts . Disclosure ......................................................................................................................... 61 Table A1: Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Heckman Probit Regression .......................................................... 83 Table A2: Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Test after Controlling for Contract Type ................... 85 Table A3: Capital Market Implications of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Tests after Controlling for Contract Type .................................................................................................................... 87 Table A4: Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Tests on Sub-Samples ................................................ 89 Table A5: Capital Market Implications of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Tests on Sub-Samples ............... 91 viii Table A6: Capital Market Implications of Choosing Timely Disclosure of Material Contracts ........................................................................................................................... 93 Table A7: Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Alternative Measures of Earnings Informativeness ...................... 94 CHAPTER I: INTRODUCTION In this dissertation, I investigate the determinants and capital market implications of firms’ choice of the current report (i.e., Form 8-K) over other SEC reports to provide a more timely disclosure for an important set of non-routine corporate events—material contracts.I Registrants are required to disclose as exhibits in their filings with the SEC any material contracts that they entered. Prior to 2004, they could fulfill this requirement by making the disclosure either immediately through a Form 8-K or in the following periodic report or registration statement.2 Due to concerns that allowing registrants to delay the disclosure of material contracts would be detrimental to maintaining the “currency and adequacy” of disclosures and hurt the market’s ability to “accurately and quickly price securities,” effective August 23, 2004, the Additional Form 8-K Disclosure and Acceleration of Filing Date Rule (hereafter, the 2004 Current Report Rule) mandates that registrants provide at least summary information about material contracts through a Form 8-K while preserving the option to file the entire contracts in the following periodic report. Nevertheless, because the limited safe harbor provision that grants this option does not protect registrants against all disclosure liabilities under the securities laws, the escalated ‘ Regulation S-K defines material contracts as significant definitive agreements that are “not made in the ordinary course of business” (emphasis added) and convey enforceable rights and obligations to the registrants. In SEC regulations, the term “material” is used when the disclosure is expected to substantially influence investment decisions (i.e., buy or sell the securities) of a reasonable investor. See 17 CPR. § 240.12b-2 (1990). Although managers could use their judgment to evaluate the materiality of contracts, they are subject to potential review by the SEC staff to ensure compliance with the regulation (Overdahl, 1991). Prior studies have shown that investors react to and assign significant value to material contracts (Carter and S00, 1999; Verrecchia and Weber, 2006). 2 In this dissertation, the filing of material contract refers to the disclosure of the entire agreement rather than some excerpts or key components of the agreement. regulatory costs brought considerable pressure for registrants to file entire contracts on a current basis (Sena, 2004).3 Opponents to the regulation, however, have expressed three concerns. First, proprietary costs from immediate disclosure of material contracts may outweigh any informational benefits derived by investors. Second, due to the elusive terminologies and wordings used in contracts, as well as the inherent differences among individuals’ information processing abilities (Mayo, 1976), a standalone disclosure of material contracts through current reports without other contextually-supporting information (e.g., financial statements, MD&A) may lead to more heterogeneity in investor assessment of the economic implications (O’Hara, 2004). Third, the short deadline for current reports may limit managerial due diligence and increase the chance of premature or incomplete disclosure, which could create unnecessary volatility and exacerbate the information problem.4 Despite the controversy surrounding the 2004 Current Report Rule, and the resulting large increase in current report filings by registrants, there is no systematic evidence on assessing corporate disclosure practices and their implications to the capital markets pre- or post-regulation. This dissertation attempts to fill this void. Given the marked attention paid to material contracts disclosures in the debate, I take a first look at the alleged costs and benefits associated with choosing Form 8-K over other SEC reports for the disclosure of material contracts. Specifically, I ask the following two questions: What are the determinants and capital market implications of choosing Form 8-K as the 3 See Appendix A for institutional details on material contracts disclosure and Form 8-K regulation. 4 For example, if firms are in the process of negotiating a series of related agreements, speedy release of the early signed ones might present a partial or biased picture of the whole series of agreements. See Comment letter from “Grundfest group” dated October 3, 2002, File No. 87-22-02. medium for disclosure of material contracts in the pre-regulation period? How did the 2004 regulation alter the disclosure timing trade-offs? Three characteristics of material contracts highlight their economic importance and shape the costs and benefits associated with the disclosure medium choice. First, material contracts are non-routine in nature, and hence, are likely to contain value relevant information about future earnings innovations as well as shifts in the eamings- generation process.5 This makes Form 8-K disclosure of material contracts a valuable supplement to routine disclosures. Second, material contracts have high disclosure credibility because in addition to liability under the anti-fraud provisions of the securities acts, they are also enforceable under commercial laws. As material contracts pre-commit firms to certain aspects of the future operation rather than act merely as a management forecast of future events, Form 8-K disclosure of material contracts is less susceptible to the “cheap talk” problem (see Newman and Sansing, 1993; Stocken, 2000; Fischer and Stocken, 2001) and helps reduce the uncertainty regarding future operating results (Verrecchia, 1990). Third, material contracts are likely to contain highly proprietary information and, hence, their immediate disclosure through current reports could represent a costly option for some firms (Verrecchia, 1983). Given these three features of material contracts, I hypothesize that firms are more likely to choose Form 8-K when their routine disclosures are less informative, when they experience higher market uncertainty due to strategic investment and financing activities (Healy and Palepu, 1993; 1995), or when they operate in product markets with less 5 For example, a long-term agreement with a new customer could specify the expected sales revenue to be generated over the duration of the contract, while a joint research and development agreement could detail the amount of additional R&D expenditures that will be made in the future. competition from incumbents (Verrecchia, 1990). Additionally, as competition is of multi-dimensional nature (Carlton and Perloff, 1994; Demsetz, 1997; Raith, 2003; Karuna, 2007), beside the competition with incumbents, I also hypothesize that firms are more likely to choose Form 8-K disclosure to deter would-be entrants when facing high potential competition (Darrough and Stoughton, 1990). From the capital market implications standpoint, as the timely disclosure of material contracts contributes to “leveling the playing field” among investors (Hakansson, 1977; Diamond and Verrecchia, 1991; Kim and Verrecchia, 1994), I predict that firms choosing Form 8-K over other SEC reports for the disclosure of material contracts are associated with a lower level of information asymmetry, as captured by the Probability of Informed Trade (PIN) (Easley et al., 1997; Brown et al., 2004), share turnover (Easley et al., 1996; Leuz and Verrecchia, 2000), and quoted market depth (Verrecchia and Weber, 2006). Based on comprehensive data of material contracts filed with the SEC, 1 identify a pre-regulation (fiscal years 2001-2003) sample of 1 1,784 firm-fiscal years with at least one material contract filed though SEC filings by 5,072 NYSE/AMEX/NASDAQ firms. Descriptive evidence shows that in 18.4% of the sample finn-years, at least one material contract was disclosed via Form 8-K, and 31.7% of the sample firms ever filed a Form 8- K for material contracts during the three years. This suggests a significant amount of variation in the disclosure medium choices. Hypothesis tests on the pre-regulation period are consistent with my predictions. Firms are more likely to choose Form 8-K as the disclosure medium when they have less- inforrnative GAAP earnings or are monitored by less-sophisticated market participants. Although prior research generally finds timelier disclosure of periodic information in the presence of sophisticated market participants (e.g., Chen et al., 2002; Sengupta, 2004; Ajinkya et al., 2005), my result shows that sophisticated market participants have a dampening effect on firms’ discretionary timely disclosure of non-routine information. I also find that firms choose Form 8-K more when they are engaged in new equity issuance and M&A activities, operate in an industry with low product substitutability, or face higher potential competition due to lower entry costs. The results on competitive costs suggest that, when the multi-dimensional nature of production market competition is considered, the seemingly conflicting predictions on the relationship between proprietary costs and disclosures from prior theoretical studies (Verrecchia, 1990; Darrough and Stoughton, 1990) can be supported at the same time. My results on the capital market implications show that, after controlling for the self-selection, firms that choose Form 8-K for material contracts disclosure have significantly lower PIN, higher share turnover, and higher quoted market depth." 7 Using the parametric relationship between PIN and the cost of equity capital reported in Easley et al. (2002), I estimate that firms choosing Form 8-K to file material contracts have a 135 basis point lower annual cost of capital. These results demonstrate that leveling-the- 6 It is possible for firms to use channels other than the SEC reports (e.g., press release) to disclose material contracts. Conversations with a securities lawyer and a manual check on a random sample show that although firms occasionally provide a condensed summary of material contracts through a press release, the disclosure of entire contracts is made only through the SEC filings. The manual check also reveals that when firms choose to report material contracts via periodic reports or registration statements, they most often do not pre-disclose such information through a press release. Regardless, any limited pre-disclosures would bias against my findings of a lower level of information asymmetry associated with Form 8-K disclosure of material contracts. 7 Given that registrants can request confidential treatment of portions of material contracts (Verrecchia and Weber, 2006), I also check the robustness of my results to the effects of redaction. The replication of Verrecchia and Weber’s (2006) study yields very similar results. After controlling for the effect of redaction, the inferences on the capital market implications of disclosure medium choice remain unchanged (see Chapter VII for details). playing-field is the dominant effect in the pre-regulation period from timely disclosure of material contracts via current reports. Using a post-regulation sample of 4,000 NYSE/AMEX/NASDAQ firms with material contracts for fiscal year 2005, I also examine the impact of the 2004 regulation. Given that escalated regulatory costs in the new regime are likely to dominate other cost considerations, I predict and find a significant reduction in the sensitivity of the disclosure medium choice to the hypothesized information demand and competitive cost determinants. The percentage of firms choosing Form 8-K to disclose at least one material contract in its entirety nearly quadrupled to 73.4%. These results are consistent with firms trading off increased regulatory costs for market-based disclosure incentives. This evidence also demonstrates an unintended consequence of the regulation that some firms are forced to choose a costly disclosure option which may hurt their competitive advantage. Results of capital market implications tests suggest that improved general market liquidity in the post-Sarbanes-Oxley Act period has driven down the association between the disclosure medium choice and information asymmetry to an undetectable level, reinforcing the notion that the marginal benefits of choosing Form 8-K disclosures will be larger with higher market uncertainty. This dissertation contributes to the literature in several ways. First, prior research on disclosure timing focuses primarily on routine information (e.g., Givoly and Palmon, 1982; Chambers and Penman, 1984; Bagnoli et al., 2002). Extant research has not examined the determinants and implications of the timely release of non-routine information despite regulators’ efforts to expedite its disclosure. This dissertation represents the first large-sample study that examines the disclosure timing of non-routine information in material contracts and its implications for the capital market. Second, instead of considering the seemingly conflicting predictions from theoretical studies (V errecchia, 1990; Darrough and Stoughton, 1990) as competing hypotheses (e.g., Verrecchia and Weber, 2006; Berger and Hann, 2007), this dissertation jointly tests and finds support for their contextual implications. Third, this dissertation adds to a growing body of literature on firms’ disclosure choices and the level of information asymmetry (e.g., Leuz and Verrecchia, 2000; Bushee and Leuz, 2005). My research differs from these studies in that I investigate the timing of non-routine information disclosure, a topic that has been previously ignored but recently gained considerable attention from both regulators and academia (Verrecchia and Weber, 2006). Finally, the dissertation also sheds light on the unintended consequences of the 2004 Current Report Rule. By increasing regulatory costs, the rule has muted the effects of information demand and competitive costs, potentially leading to suboptimal disclosure timing decisions. The remainder of the dissertation is organized as follows. In Chapter 11, I review prior research and develop hypotheses. Research design is provided in Chapter 111. Chapter IV contains the sample selection procedure and descriptive evidence. Chapter V presents results from hypothesis tests. Chapter VI investigates the consequences of the 2004 regulatory change and Chapter VII examines the relationship between disclosure medium choice and redaction. Concluding remarks are provided in the final chapter. CHAPTER II: PRIOR RESEARCH AND HYPOTHESIS DEVELOPMENT 2.1 Prior Research Form 8-K was devised to address the criticism that the SEC disclosure system was focused on historically-oriented accounting information and provided delayed disclosures that did not satisfy the needs of investors (Benston, 1969, p.520). Although prior research has studied current reports, its focus has been limited to market reactions surrounding the filings. Pastena (1979) finds significant abnormal market returns around the time when registrants issue a press release regarding the filing of the current report disclosing the non-routine events. Carter and 800 (1999) use relatively recent data (i.e., 1993) to examine the relationship between the timeliness of Form 8-K report (i.e., the number of days between the event date and the filing date) and the immediate market reaction to Form 8-K filings. They find a significant market reaction around the event date and that the magnitude of market reaction around the filing date is positively related to how quickly firms file Form 8-K reports. Using intraday transactions data, McLelland (2003) examines the transaction size surrounding Form 8-K filings and finds that small-sized trades precede the large-sized ones. He infers that, while large investors wait until Form 8-K disclosure to trade, small investors may not rely on 8-K disclosure for trading.8 However, prior research does not examine an important aspect of Form 8-K, i.e., the decision whether or not to use Form 8-K over other less-timely disclosure media (e.g., periodic reports and registration statements) for disseminating significant non-routine 8 There are also numerous studies on disclosure of auditor change through Form 8-K reports (See Whisenant et al., 2003 for a review). information. I argue that examining the choice of disclosure medium is particularly relevant to justify regulators’ efforts in promoting timely disclosure of non-routine events through Form 8-K reports. Consequently, the focus of the dissertation is to examine the determinants and capital market implications of the disclosure medium choice by exploiting the natural setting in which the choice of Form 8-K as the medium to disclose an important set of non-routine events—material contracts—was essentially voluntary prior to the 2004 regulatory change. To date, the only study that focuses on the disclosure of material contracts is Verrecchia and Weber (2006), who use a hand-collected sample of 450 small firms to examine firms’ decisions to redact proprietary information from the filed material contracts. They find firms that are not issuing new securities, operate in a competitive industry, or experience poor performance are more likely to redact information. They also show that redacting firms have a higher level of information asymmetry. However, the small sample size, as well as the inclusion of only relatively small firms, prevents them from exploring the effects of other economic factors (Verrecchia and Weber, 2006, p.794). Furthermore, as the decision to redact may be related to the choice of disclosure medium, a large sample study on the choice of disclosure medium can provide a more . . . . 9 comprehensrve picture on firms’ material contracts disclosure. 9 On the one hand, if firms intend to maximize the effect of withholding proprietary information, they may choose to redact and delay the disclosure of material contracts at the same time. On the other hand, if firms want to soften the effect of redaction on information asymmetry, they may choose Form 8-K disclosure of material contracts. 2.2 Firms’ Incentive to Use Form 8-K as the Disclosure Channel for Material Contracts Given the three characteristics of material contracts discussed in the introduction, I develop testable hypotheses in this chapter on scenarios where these characteristics would be most relevant to firms’ disclosure decisions. First, I employ two constructs— eamings inforrnativenss and investor sophistication—to capture the effectiveness of routine disclosures and test the supplementary role of Form 8-K disclosure of material contracts. Second, I consider changes in capital structure and M&A activities as scenarios with high market uncertainty where the high credibility of material contracts disclosures would have a large impact. Third, I use product substitutability and entry costs to explore the effects of proprietary costs on Form 8-K disclosure of material contracts. 2.2.1 Earnings Informativeness, SOphisticated Market Participants and Form 8-K Disclosure of Material Contracts Prior research shows that when reported GAAP earnings are less informative for valuation purposes, firms are more likely to speed up the disclosure of additional financial statement items in earnings press releases to mitigate the information problem (Chen etal., 2002; Wasley and Wu, 2006; D’Souza et al., 2006). Because material contracts are non-routine in nature, and hence, are more likely to provide additional valuable information on future earnings innovation as well as shifts in the eamings- generation process, Form 8-K disclosure of material contracts makes an effective disclosure mechanism to supplement historical and forecasted earnings information. Thus, I posit that firms provide timely disclosure of non-routine information when their periodic earnings-related information is less informative, leading to the following 10 hypothesis: '0 Hla: Ceteris paribus, firms with less-informative GAAP earnings are more likely to choose Form 8-K over other SEC reports for the disclosure of material contracts. Dye (1998) suggests that firms will increase disclosure frequency when catering to a more sophisticated investor clientele. Consistently, extant literature finds that firms monitored by sophisticated market participants face higher demand for timely earnings information (Sengupta 2004; Ajinkya et al., 2005). However, whether such firms would also make more timely disclosure of non-routine information is not readily apparent. In contrast to the implications of disclosure theories, other arguments can be advanced to support firms’ disincentives to make timely material contracts disclosure in the presence of sophisticated market participants. The first argument is based on sophisticated market participants’ information rents. While the average investor is likely to be handicapped due to the non-routine nature of material contracts, SOphisticated market participants may privately acquire the information with their superior analytical and information acquisition skills. Rather than requesting firms to make immediate public disclosure, sophisticated market participants may prefer to exploit their information advantage to compensate for their private information acquisition efforts (Kyle, 1985; McNichols and Trueman, 1994).H A second argument could be based on sophisticated market participants’ fixation on earnings. As institutional investors generally place high 1° An alternative argument could be that Form 8-K disclosure of material contracts weakens the ability of GAAP earnings in driving market returns, though it leads to the same hypothesis of a negative association between GAAP earnings infonnativeness and firms’ propensity to choose Form 8-K for the disclosure of material contracts. However, as I measure the GAAP earnings informativeness using data from prior years (see Chapter 3.2), my empirical results are more pertinent to the original argument than to this alternative line of reasoning. ” This is not the case for earnings information because equity analysts per se have to provide forecasts on earnings and they are evaluated and compensated for their earnings forecast ability. In addition, analysts may also privately incorporate their information on material contracts into their earnings forecast and exhibit superior forecast ability. ll emphasis on near-term profits (Porter, 1992; Bushee, 1998) and equity analysts focus extensively on earnings-related information (Asquith et al., 2007), they may have limited attention to non-routine events. Third, given the existence of sophisticated information intermediaries who gather, analyze, and disseminate information on public companies, and thereby reduce the level of information asymmetry (Roulstone, 2003), the marginal benefit to firms from providing additional disclosures may be limited. Taken together, I do not make a directional prediction due to the conflicting arguments on the effects of sophisticated market participants on disclosure behavior: Hlb: Ceteris paribus, the extent to which firms are monitored by sophisticated market participants is unrelated to firms’ choice of Form 8-K over other SEC reports for the disclosure of material contracts. 2.2.2 Changes in Capital Structure, Mergers and Acquisitions and Form 8-K Disclosure of Material Contracts Ross (1977) and Myers and Majluf( 1984) suggest significant market uncertainty is associated with changes in the capital structure of firms. Consequently, when firms raise public capital, they have incentives to mitigate the adverse effects of information asymmetry on the cost of capital (Bower and Hansen, 1985; Dierkens, 1991) by voluntarily providing additional disclosures (Gibbins et al., 1990; Lang and Lundholm, 1993; Healy and Palepu, 1993; 1995). Reported earnings and other financial disclosures (e.g., earnings guidance) may be less credible due to managers’ ability to be opportunistic around securities issuance.l2 Given the high disclosure credibility of material contracts, immediate disclosure of key business relationships through current reports becomes a relatively more reliable and effective disclosure mechanism. In addition, changes in '2 Both Teoh et al. (1998) and Shivakumar (2000) find evidence of earnings management before seasoned equity offerings, though they have different interpretations. l2 capital structure are likely related to significant changes in the investment opportunity set, which investors can better assess through Form 8-K disclosure of material business relationships. Taken together, I predict the following: H2a: Ceteris paribus, firms with new securities issuance are more likely to choose Form 8-K over other SEC reports for the disclosure of material contracts. As in the case of securities issuance, firms engaged in mergers and acquisitions are associated with significant information asymmetry as well (Grossman and Hart, 1981; Meyer and Majluf, 1984; Amihud etal., 1990). The market has uncertainty regarding the legitimacy of the transaction (i.e., whether the takeover represents a positive NPV project or is merely a part of an empire-building scheme). Similar to the case of new securities issuance, eamings-related information would be perceived to be of low quality due to managers’ opportunistic behavior around takeover events (Erickson and Wang, 1999; Louis, 2004). Therefore, firms engaged in takeovers will have higher incentives to use the more timely Form 8-K disclosure of material contracts to ease the adverse selection problem, leading to the following hypothesis: H2b: Ceteris paribus, firms with mergers and acquisitions activities are more likely to choose Form 8-K over other SEC reports for the disclosure of material contracts. 2.2.3 Product Substitutability, Entry Costs and Form 8-K Disclosure of Material Contracts Verrecchia (1983) suggests that firms operating in highly competitive industries are likely to face large proprietary costs of disclosure (p.182). However, whether product market competition inhibits or spurs corporate disclosure is far from clear (Healy and Palepu, 2001). While Verrecchia (1990) argues that a market with seasoned competitors acts as a deterrent to disclosure, Darrough and Stoughton (1990) contend that firms will disclose more in the presence of elevated competition to discourage potential entry into 13 the product market. Taken together, these studies imply that it is important to understand the multi-dimensional nature of competition, which includes both competition with other incumbents and that with potential entrants (Raith, 2003; Karuna, 2007). Hotelling (1929) suggests that competitors in an existing market may have “undue tendency” to mimic each other in all essential aspects of the product. While firms may have an incentive to generate rents through product differentiation (d’Aspremont et al., 1979), the rents can easily fade away if the firms fail to prevent imitation in a competitive market. Therefore, in a product market environment with high substitutability, firms with differentiating products will preserve their economic rents by refraining from or delaying the disclosure of highly proprietary information, leading to the following hypothesis: H3a: Ceteris paribus, firms in industries with high product substitutability are less likely to choose Form 8-K over other SEC reports for the disclosure of material contracts. Darrough and Stoughton (1990) demonstrate that when the disclosure effects on both capital and product markets are considered, the equilibrium strategy is for the incumbent to make full disclosure (non-disclosure or partial disclosure) when the entry cost is relatively low (high). They argue that the equilibrium disclosure strategy is immune to the types of the incumbent’s private information. The incumbent will disclose unfavorable news to deter potential entrants. When having favorable news, the incumbent will also disclose it because (1) she has incentives to inform the capital market, and (2) a separating equilibrium of non-disclosure is not sustainable as potential entrants can rationally infer the news type. This leads to the following hypothesis with respect to entry costs: H3b: Ceteris paribus, firms in industries with low entry costs are more likely to choose Form 8-K over other SEC reports for the disclosure of material contracts. i4 2.3 Disclosure of Material Contracts through Form 8-K and Information Asymmetry The preceding hypotheses relate to the determinants of the disclosure medium choice for material contracts. In this chapter, 1 turn my focus to the capital market implications of this choice, and specifically, its impact on the level of information asymmetry. If firms with material contracts choose other SEC reports instead of Form 8-K, the delayed disclosure could contribute to information asymmetry among investors (Beaver and Demski, 1974; and Hakansson, 1977),'3 leading to an adverse selection problem (Healy and Palepu, 2001; Verrecchia, 2001). As a rational response, uninformed investors will, on average, price protect themselves. In turn, the actions of uninformed investors will increase the bid-ask spread in the secondary markets, and further, reduce the willingness of the uninformed investors to trade (Easley et al., 1997; Brown et al., 2004). Consequently, the liquidity will decrease (Copeland and Galai, 1983; Glosten and Milgrom, 1985), the required return premium will increase (Constantinides, 1986; Amihud and Mendelson, 1986), and the trading volume will decline (Easley et al., 1996; Leuz and Verrecchia, 2000). Form 8-K disclosure of material contracts can mitigate the adverse selection problem and increase market liquidity by ensuring “equal access to information” (Hakansson, 1977) and “leveling the playing field” among investors (Diamond and Verrecchia, 1991; Kim and Verrecchia, 1994). This effect works in two ways. First, immediate disclosure of highly detailed information would make it harder for certain '3 Although it is difficult to predict the occurrence of material contracts in advance, competent analysts may identify budding business relationships when actively monitoring a firm and its industry. investors to benefit from being privately informed, and hence, reduces the chance for uninformed investors to trade with their informed counterparts. Second, when disclosed, the credibility of material contracts helps decrease the uncertainty about firm value, and hence, reduce the marginal benefit of being better informed (Diamond, 1985). The disincentive for private information acquisition arises from the inability of informed traders to precisely predict when their information advantage would be eliminated by firms’ disclosure of material contracts. Taken together, I predict a negative relationship between information asymmetry and the choice of Form 8-K as the disclosure medium, leading to the following hypothesis: H4: Ceteris paribus, firms choosing Form 8-K over other SEC reports for the disclosure of material contracts have a lower level of information asymmetry. However, the opposite may be expected for the following reasons. First, unlike material contracts disclosed through periodic SEC filings or registration statement which are accompanied by financial statements, MD&A, and other contextually supporting information, those reported in Form 8-K are generally disclosed on a standalone basis. The isolated nature may make it hard for investors (especially those less sophisticated) to interpret the information and to assess its impact on firms’ future operations.‘4 This is especially pertinent to material contracts which are legal documents with elusive terminologies and wordings. The low readability may make it even harder for investors to grasp the information (Li, 2006) or interpret information in the same way. Therefore, equal access to timely material contracts disclosures does not necessarily lead to investors '4 There was a requirement of a “mini-MD&A” with respect to the Form 8-K disclosure of material contracts in the Proposing Rule for the 2004 Current Report Rule, but the Final Rule removed this requirement due to some commentators’ concerns for the limited time to provide a thorough and meaningful management discussion and analysis. See comment letter from the “Grundfest Group” dated October 3, 2002. 16 being equally well informed due to the inherent differences among individuals’ information processing abilities (Mayo, 1976). Even worse, the heterogeneous interpretations may create higher information asymmetry among investors. Second, Arya and Mittendorf (2005) suggest that firms may manipulate the information environment by selectively disclosing certain information to satisfy the external demand (and to guide the herd), while hiding other relevant information. If firms use material contracts disclosures opportunistically to hide more significant information, I expect a higher level of information asymmetry when firms choose Form 8-K disclosure of material contracts. Third, the short time horizon to disclose material contracts through Form 8-K may put management under pressure, which diverts them from due diligence in disclosure.” This increases the chances of premature or incomplete disclosures, which could create unnecessary volatility and exacerbate the information asymmetry problem. If any of the three arguments is valid, I expect a higher level of information asymmetry associated with the firms choosing Form 8-K over other SEC filings for the disclosure of material contracts. 2.4 Impact of the Increased Regulatory Costs in the Post-Regulation Period While the above hypotheses focus on the pre-regulation period, I now consider how the 2004 regulation altered the disclosure timing trade-offs. As discussed in the introduction, the 2004 regulatory change imposes considerable pressure on registrants to file the entire contracts on a timely basis through current reports. From the determinants '5 Optimally, managers may need more time to consult with directors and technical experts (i.e., company’s business, legal, and financial advisors), who, unlike the managers, may not fully participate in the negotiation of every contract and are, hence, unlikely to provide “real time” consultancy (see the comment letter from the American Bar Association dated September 12, 2002). 17 perspective, some firms that did not use Form 8-K under the pre-regulation regime due to either information demand or competitive costs considerations may choose current reports in the post-regulation era to reduce their exposure to regulatory costs. Therefore, the escalated regulatory costs in the new regime would generally mute other disclosure incentive considerations by nudging registrants towards a timelier filing of material contracts, leading to the following hypothesis: HSa: F irms’ choice of Form 8-K over other SEC reports for the disclosure of material contracts has a lower sensitivity to information demand and competitive costs incentives in the post-regulation period than in the pre-regulation period. From the capital markets standpoint, if Form 8-K disclosure of material contracts becomes a more prevalent practice in the post-regulation period, its association with the level of information asymmetry would diminish. For instance, if firms choose Form 8-K to disclose material contracts regardless of their information environment, the disclosure medium choice is less likely to be associated with the level of information asymmetry. Additionally, given that recent research documents improved general market liquidity in the post-Sarbanes-Oxley Act period (Jain etal., 2006), the marginal benefits of choosing Form 8-K as the disclosure medium are expected to decrease. Collectively, both arguments lead to the following prediction: HSb: Firms’ choice of Form 8-K over other SEC reports for the disclosure of material contracts has a lower association with the level of information asymmetry in the post-regulation period than in the pre-regulation period. 18 CHAPTER III: RESEARCH DESIGH In this chapter, I first describe the method for identifying and extracting information from material contracts filed by firms and then develop empirical models to test the hypotheses outlined in the previous chapter.‘6 3.1 Identifying and Extracting Information from Material Contracts Although material contracts can be filed with different SEC reports, there are two features of the EDGAR filing system that enable me to consistently extract information on material contracts. First, material contracts are always presented as exhibits after the main body of SEC filings. Second, the EDGAR system always generates several lines of brief descriptions on the top of each material contract and the first line always starts with “EX-10”. Exploiting these features of the SEC filing system, I use PERL programs to search current reports, periodic reports and registration statements to identify all material contracts filed with the SEC. Because sometimes a material contract could be filed more than once using different SEC reports (Verrecchia and Weber, 2006), I eliminate duplicate contracts by keeping only the first one filed.l7 I then extract relevant descriptive information (i.e., form of the SEC report, entry or amendment date, status of redaction, and type of contract) from each of the contracts.‘8 '6 I focus on the hypotheses related to the pre-regulation period (i.e., H1 through H4) in this chapter. Analysis of the post-regulation period hypotheses (i.e., H5a and H5b) is discussed in Chapter VI. '7 For example, on March 9, 2004, Lodgian Inc. filed “EX-10.143 Second Amendment to Lease Agreement” on both 10-K and S-l, Continental Airlines Inc. filed “EX-10.39(L) Amendment No 12 to Purchase Agreement DCT 05498” with both lO-K on February 21, 2002 and lO-K/A on March 1, 2002. To eliminate duplicates, I keep only the one filed earlier and, if filed on the same day, keep the one filed with periodic filings over registration statements and original filings over amendment filings. '8 The details of the procedure are provided in Appendix B and Appendix C. 19 I consider the twelve-month period ending four months after the end of the fiscal year to determine whether at least one material contract was filed for a specific fiscal year. I choose this window because (1) any unreported material contracts during a fiscal year are required to be filed with the lO-K report, and (2) virtually all the 10-K reports are filed within 120 days after fiscal year end (Easton and Zimijeski, 1993; Griffin, 2003; Li and Ramesh, 2007b). The yearly regression discussed below will be based on such a twelve-month period. 3.2 Development of Models I employ the following model to test my hypotheses on the determinants of firms’ incentives to use Form 8-K over other SEC reports for material contracts disclosure: Dummy8K i = '80 + flIERCi + ,BZAdeSQRi + ,63NumAnalysti + fl4lnst0wnl. + ,BSEquityIssuel. + ,86Debtlssuei + fl7M&AI. + flSPCMargini + ,69LnPPEI. (l) + ,6] OIPIntensl. + ,6] IROAI' + ,8] 2Loss]. + ’61 3LnMVEl. + ,6] 4LnNumMCl. + 5!. where the dependent variable Dummy8K is a dummy variable indicating whether the firm filed at least one material contract through Form 8-K during the twelve-month period, and zero otherwise. The definitions of all the test variables are provided in Appendix D. The proxies for earnings infonnativeness (ERC and AdeSQR), the sophistication of market participants (NumAnalyst and InstOwn), changes in capital structure (Equip/Issue and Dethssue), and M&A activities (M&A) are based on prior literature, so I refrain from providing a detailed discussion.'9 '9 I measure earnings infonnativeness and the sophistication of market participants using data from prior year(s) to avoid possible endogeneity issues. In addition, 1 identify equity issuance, public debt issuance, and mergers and acquisitions directly from the SDC database to avoid any measurement error associated with using financial statement information to construct the proxies. 20 I use the industry price-cost margin (PCMargin) as a proxy for product substitutability. Extant Industrial Organization literature suggests that high (low) levels of product substitutability manifest through low (high) levels of price-cost margin (Carlton and Perloff, 1994; Demsetz, 1997). Similar to Karuna (2007), I measure the price-cost margin as industry sales divided by industry operating costs and predict a positive slope for this variable. Conceptually, industry entry costs refer to the minimal level of investment that an industry must make before commencement of operations (Karuna, 2007). Because different industries have different structures for start-up costs, a single measure may not be reflective of entry costs for both infrastructure-intensive industries (e. g., manufacturing) and intellectual property based industries (e.g., software). Therefore, I employ two measures, LnPPE and IPIntens, to capture the entry cost related to the infrastructure and intellectual property investments, respectively. Similar to Karuna (2007), I compute LnPPE as the natural logarithm of the market-share-weighted average gross value of property, plant and equipment (PPE) for each industry. Due to the absence of a natural financial statement item for the capitalized value of intellectual property, I use an industry dummy instead. Specifically, IPIntens takes a value of one for the drugs, R&D services, programming, computers, electronics, or precise measurement instrument industries, and zero otherwise. I predict negative slopes for both proxies. I include firm performance (RCA and Loss), size (LnMVE) and the number of material contracts filed during the twelve-month period (LnNumMC) as controls as they have been shown to affect material contracts disclosure (Verrecchia and Weber, 2006). Finally, I include year dummies in the model (not shown) to capture any inter-temporal 21 variations. My second set of analysis focuses on the capital market implications of firms’ disclosure medium choice for material contracts. Specifically, I estimate the following models: PINI. =70 + leummy8Ki + 72NumAnalysti + y31nst0wni + 74LnNumMCi . . (2) + ySLnMVEI. + 76NYSEI' + 77AMEX i + 78LnPrzceI. + yglnszllsl. + £1. MonthlyTurnoverl. = 70 + leummy8Ki + 72 NumAnalystl. + 73Inst0wnl. + 74LnNumMCi 3 . . ( ) + ySLnMVEi + y6NYSEi + y7 AMEXI. + ySLnPrtcel. + 791nszllsi + £1. DollarDepthi =70 + leummy8Kl. + yZNumAnalysti + 73Inst0wni + y4LnNumMCi (4 + 75LnMVEi + y6NYSEi + 77AMEX i + 78LnPricel. + y91nvMillsl. + at. where the dependent variable of Model (2), PIN, is the probability of private-information- based trading, estimated according to Easley et al. (1997) for the twelve-month period. Prior studies argue that PIN is a more direct measure of information asymmetry than, and is hence not subject to the various econometrics and interpretation issues associated with, spread-based proxies (Callahan et al., 1997; Brown et al., 2004). The dependent variable of Model (3), MonthlyTurnover, is the average monthly share turnover during the twelve- month period. Because uninformed traders shy away from stocks with high probability of private-information-based trading, prior studies argue that share turnover is negatively related to the level of information asymmetry (Easley et al., 1996; Leuz and Verrecchia, 2000). The dependent variable used in Model (4), DollarDepth, is the average daily median quoted dollar depth during the twelve-month period.20 The intuition for this proxy is that market makers will reduce the quoted depth in response to increased information 2° The use of long-window information asymmetry measures eases the concern regarding the “news effect,” which occurs only temporarily around an event (see Leuz and Verrecchia, 2000). 22 asymmetry (Verrecchia and Weber, 2006). In addition to the explanatory variable, Dummy8K, I add several controls in the models by following prior studies, namely, the sophistication of market participants (NumAnalyst and InstOwn) from Roulstone (2003) and Brown et a1. (2004); and the number of material contracts filed (LnNumMC), firm size (LnMVE), exchange membership (NYSE and AMEX) and average share price (LnPrice) from Verrecchia and Weber (2006). To control for the self-selection problem associated with firms’ disclosure medium choice, I also include the inverse Mills ratio (InvMills) estimated from the Model (1)2] In addition, I include both year and industry dummies in the model (not shown) to capture any inter-temporal and cross-industry variations. Although Dummy8K reflects firms’ propensity to choose Form 8-K over other SEC reports for the disclosure of material contracts, one concern is that it captures only the occurrence, but not the extent, of this choice. To address this issue and provide a robustness check, I replace Dummy8K in all the above models with Percent8K, which is the percentage of material contracts that a firm filed through Form 8-K during the twelve- month period. For the determinants model (Model (1)), because Percent8K is a percentage variable with high incidence of extreme values (i.e., 0% and 100%), an OLS regression would be inappropriate for two reasons: the effect of any independent variable cannot be constant over its range, and the OLS regression cannot ensure that the predicted value will fall into the unit interval (Papke and Wooldridge, 1996). Following 2' Other than including the inverse Mills ratio in the model, an alternative method to control for self- selection is to substitute (y2'x2) for Dummy8K, where 20.0% 10.0% 0.0% Cumulative Percentage of Material Contracts _L i 120 ~ 150 180 1 240 330 , 360 390 420 450 480 ' Disclosure Lag —- Material Contracts Filed through Current Reports -- Material Contracts Filed through Periodic Reports or Registration Statements Disclosure Lag is the number of calendar days between the material contract event date and the disclosure date. This figure is based on 73,604 material contracts in the period 2001-2003. 46 Table 1 Descriptive Information on Firms' Material Contracts Disclosure through Form 8-K Panel A: Incidence of material contracts for 4,399 firms with continuing information over the fiscal years 2001-2003a Number of Fiscal Years with At Least One Material Contract Frequency Percentage 0 384 8.7% I 439 10.0% 2 866 19.7% 3 2,710 61.6% Panel B: Incidence of material contracts filed through Form 8-K by 2,710 firms with at least one material contract for each of the three fiscal years 2001-2003 Number of Fiscal Years with At Least One Material Contract Filed Through Form 8-K Frequency Percentagg 0 1,724 63.6% 1 633 23.4% 2 251 9.3% 3 102 3.8% Panel C: Number of material contracts per firm and percentage of firms choosing Form 8-K for at least one material contract, by fiscal year 2001 2002 2003 2000 -2003 Number of Firms 4,151 3,945 3,688 1 1,784 Number of Material Contracts per Firm Mean 6.4 6.8 6.3 6.5 Median 5 5 5 5 Percentage of Firms Choosing Form 8-K 0 0 o 0 for At Least One Material Contract 17'0 /° 18'2 /° 20-2 /° 18-4 /0 a The 4,399 firms are identified from the 15,140 firm-fiscal years that: ( l) are in the COMPUSTAT/CRSP merged database over the fiscal years 2001-2003: (2) are not in the banking industry; (3) are traded on NYSE, AMEX or NASDAQ; and (4) can be linked to the EDGAR system. b . . This is based on the 11,784 firm-fiscal years With at least one material contracts. 47 Table 2 Descriptive Information on Form 8-K Disclosure of Material Contracts by Contract Typesa Number of Material Material Contracts Filed Contracts throngh Form 8-K Contract Type (% of All Material Contracts) Number % within the Type Business-Related 9,423 1,079 1 1 .5% (12. 3 %) Leases-Related 4,201 224 5 .3% (5.5 %) Asset Acquisition or 2,984 922 30.9% Disposition (3. 9 %) Equity-Related 5,944 1,780 30.0% (7. 7 %) Business Structure 1,604 223 13.9% Changes (2.] %) Debt-Related 16,861 2,400 14.2% (22.0 %) Employment-Related 3 1,559 874 2.8% (41.1 %) Other 4,251 399 9.4% (5.5 %) Total 76,827 7,910 10.3% (I 00 %) a This table is based on all unique material contracts filed as exhibits in various SEC reports (i.e., current reports, periodic reports, and registration statements) by sample firms for the fiscal years 2001-2003. 48 Table 3 Descriptive Statistics Variablesa N Mean Std. Dev. Ql Median Q3 Dummy8K 10,504 0.183 0.386 0.000 0.000 0.000 Percent8K 10,504 0.081 0.216 0.000 0.000 0.000 ERC 10,504 3.553 14.842 -0.719 1.082 5.312 AdeSQR 10,504 0.077 0.255 -0.068 0.030 0.186 NumAnalyst 10,504 4.342 6.052 0.000 2.000 6.000 InstOwn 10,504 0.372 0.307 0.053 0.354 0.643 Equitylssue 10,504 0.076 0.265 0.000 0.000 0.000 Dethssue 10,504 0.053 0.224 0.000 0.000 0.000 M&A 10,504 0.321 0.467 0.000 0.000 1.000 PCMargin 10,504 1 . 109 0.173 1.025 1.081 1.144 LnPPE 10,504 6.990 2.141 5.563 7.079 8.504 IPIntens 10,504 0.249 0.433 0.000 0.000 0.000 ROA 10,504 -0.119 0.389 -0.113 0.011 0.053 Loss 10,504 0.437 0.496 0.000 0.000 1.000 LnMVE 10,504 5.545 2.184 3.997 5.580 7.019 LnNumMC 10,504 1.481 0.904 0.693 1.609 2.197 NYSE 10,504 0.368 0.482 0.000 0.000 1.000 AMEX 10,504 0.078 0.269 0.000 0.000 0.000 LnPrice 10,504 2.159 1.289 1.295 2.377 3.168 MonthlyTurnover 10,504 0.141 0.180 0.043 0.088 0.169 PIN 10,043 0.205 0.096 0.135 0.193 0.259 DollarDepth 10,414 82.6 101.8 26.3 49.0 103.9 a All the variables are defined in Appendix D. 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E ... a. .4. .m. .N. a. 33......» 3.2.8. .. .3... £3.02 m=o_.mo__aE_ .8132 3:qu ”m 3...... o 51 Table 5 Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosurea Fractional Response Pmb't Regressmns Variable Regressions 2:: (DV Dummy8K) (DV=Percen18K) Coeff. Coeff. Coeff. Coeff. Variables (Z-stat) (Z-stat) (Z-stat) (Z-stat) (1) (2) (3) (4) (5) Intercept -0.755 -1.505 -1.328 -1.491 (-5.31) **" (-10.13) m (-9.32) m (-10.31) *** ERC — -0.005 -0.003 -0.003 -0.002 (-4.17) m (-2.38) "* (-3.05) m (~1.98) " AdeSQR - 0.036 0.040 -0.015 -0.012 (0.59) (0.66) (-0.27) (-0.22) NumA nalyst ‘.’ -0.020 -0.013 -0.020 -0.010 (-4.44) "* (-2.75) “* (-4.29) *“ (-2.06) “ InstOwn '2 -0.499 -0.283 -0.575 -0.376 (-6.99) "* (-3.73) '** (-8.08) **" (-5.02) *“ Equitylssue + 0.364 0.355 0.203 0.242 (6.81) '" (6.40) m (4.04) "* (4.71) "‘ Debt/ssue + -0.007 0.077 -0.006 0.090 (-0.09) (0.94) (-0.08) (1.17) M&A + 0.155 0.214 0.152 0.201 (4.50) m (5.87) m (4.63) *‘* (5.96) "* PCMargin + 0.154 0.407 0.313 0.486 (1.51) (3.95) “* (3.08) *“ (4.78) “* LnPPE — -0.008 -0.008 -0.020 -0.017 (-0.92) (-0.97) (-2.42) ** (-1.94) ' lPIntens — -0.053 -0.105 0.002 -0.044 (-1.32) (-2.48) ** (0.05) (-1.10) ROA -0.194 -0. 149 (-4.47) ”* (-3.91) *“ Loss 0.1 16 0.064 (3.02) m (1.78) " LnMVE -0.062 -0.066 (-5.05) ”’ (-5.77) ”* LnNumMC 0.404 0.101 (21.27) "‘ (5.42) “* Coefficients and z-statistics on fiscal year indicator variables are suppressed. Pseudo R2 0.034 0.106 0.038 0.052 % of correct classification 81.74% 82.04% Number of observations 10,504 10,504 10,504 10,504 52 Table 5 (cont'd) *, **, "*2 p < 0.10, p < 0.05 and p < 0.0l, respectively, two-tailed tests. z-statistics for the pooled regressions have been adjusted for heteroskedasticity and firm-specific clustering in the panel data. a This table is based on a sample period from 2001 to 2003. All the variables are defined in Appendix D. ERC , InstOwn , ROA have been winsorized at the top and bottom 1% of their respective distribution. Probit regressions are used to estimate the models with Dummy8K as the dependent variable, while fractional response variable regressions developed by Papke and Wooldridge (1996) are used to estimated the models with Percent8K as the dependent variable. Results on the partial model (i.e., without control variables ROA , Loss , LnMVE and LnNumMC) are presented in Column (2) and (4). 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This disclosure requirement became mandatory with the passage of the Securities Acts Amendments of 1964 (l 964 Amendments)“ Item 601 of Regulation S-K of 1982 (and the comparable item of Regulation S-B) defines a material contract as a definitive agreement that is “not made in the ordinary course of business which is material to the registrant and is to be performed in whole or in part” (emphasis added).42 Item 601 identifies several types of contracts as reportable material contracts. The details are provided in Appendix C. Prior to the 2004 amendment to Form 8-K, registrants were not required to file or disclose information on material contracts immediately through a Form 8-K report. After entering into a material contract, registrants could wait until the next periodic report or registration statement, whichever came first, to file the entire contract with the SEC. The only requirement was that registrants had to include, in their IO-Ks and registration statements, all unexpired material contracts as exhibits to such filings. Registrants normally fulfill this requirement by filing all unreported contracts as exhibits and incorporating all previously filed ones by reference. Alternatively, registrants could have 4' Prior to the I964 Amendments, disclosure of material contracts and keeping such disclosure “reasonably current” was not mandatory for SEC registrants, except that the 1959 “Amendments to Rule 133 and Adoption of New Registration Form S-l4” required companies to report all material contracts with their registration statements (I959 SEC LEXIS 320; I964 SEC LEXIS 101, 29 F R l3455). The 1964 Amendments mandate the filing of material contracts that are not wholly performed prior to July l, 1962. 42 As the SEC does not provide guidance on what constitutes “material,” registrants have to follow existing case law as well as statements of the views of the SEC and its staff regarding materiality (such as Staff Accounting Bulletin No. 99, August 1999). According to the Supreme Court, information is material if “there is substantial likelihood that a reasonable stockholder would consider it important in making an investment decision about the company; or the information would have been viewed by the reasonable investor as having significantly altered the total mix of information that is available about the company.” (See Gehr et al., 2004) 68 4 ” 3 on Form chosen to voluntarily file a material contract as Item 5 “Other important event 8-K. Although this item had no specific deadline (Carter and 800, 1999), registrants typically filed it within several days of the effective date of the material contract (see Chapter IV). A.2 The 2004 Regulatory Change Effective August 23, 2004, Form 8-K was amended so that the entry into a material contract was added to the list of events that trigger a mandatory Form 8—K filing. Under the revised disclosure requirements, Item 1.01 is used to report any newly entered material contracts or any contracts that have become material after an amendment.44 However, registrants can initially provide a summarized narrative disclosure of material contracts in a Form 8-K (i.e., the entry or amendment date, identity of the parties, and a brief description of the terms and conditions), but the entire contract must be filed with the immediately following periodic report.45 The Form 8-K filing deadline for items 1.01 is four business days after the effective date. Due to the potential economic significance of material contracts, these disclosure requirements in the 2004 Current Report Rule are considered “probably the most important for most companies” (Fried, Frank, Harris, Shriver & Jacobson LLP, 2004).46 ‘3 This voluntary disclosure item number has since been changed to 8.01 under the 2004 Current Report Rule. 44 Although the 2004 Current Report Rule uses the term “material definitive agreement” rather than “material contract,” it specifies in Section 1 that “[t]he item parallels Items 601(b)( 10) of Regulation S-K with regard to the types of agreements that are material to a company, a standard already familiar to reporting companies.” Thus, these two terms are interchangeable from a regulation perspective. ‘5 The requirement in the Proposing Rule to file the entire material contract as an exhibit to Form 8-K was eliminated in the Final Rule. ‘6 As shown in Chapter IV, in each year of my sample period, approximately 70% of the registrants listed on NYSE, AMEX or NASDAQ had at least one material contract. 69 The SEC adopted these regulatory changes to implement Section 409 of the Sarbanes-Oxley Act “Real Time Issuer Disclosure,” and to allow the market to assimilate “unquestionably or presumptively” material information into the securities prices on a more rapid fashion. In response to the Proposing Rule, commentators expressed concerns that registrants would face potential liability under the Exchange Act Section 10(b) and Rule 10b-5 for failing to quickly assess the materiality of contracts.47 In response to these concerns, the Final Rule provides a limited safe harbor from public and private claims under Section 10(b) and Rule 10b-5 solely for failing to file or disclose information on material contracts in a timely fashion as Item 1.01 or 1.02. The safe harbor extends only until the due date of the next periodic filing or registration statement. However, the SEC explicitly “encourage[s] companies to file the exhibit with the Form 8-K when feasible” (Final Rule). More importantly, the safe harbor does not protect registrants against liability for failure to meet disclosure obligations under other provisions of the securities laws (Sena, 2004). First, registrants are not shielded from meeting disclosure obligations under sectionsl3(a) and 15(d) of the Exchange Act, which require issuers to file periodic and current reports with the SEC and keep them accurate and current. For example, the limited safe harbor does not extend to Section 13(a), and therefore, a registrant could face an SEC enforcement action for failing to report material contracts on a timely basis. Second, any material misstatements or omission in a Form 8-K filing would still be subject to Rule lOb-S liability. Third, the safe harbor for material contracts does not “7 See the comment letters from National Association of Real Estate Investment Trusts dated August 26, 2002; Association of the Bar of the City of New York dated August 26, 2002; and Shearman & Sterling dated August 30, 2002. 70 release registrants from their obligation under Exchange Act Rules 13a-15(a) and 15d- 15(a) to establish an efficient disclosure control system that ensures timely Form 8-K reports. Taken together, although the 2004 Current Report Rule offers a limited safe harbor, it brings considerable pressure and provides incentives for registrants to file material contracts on a more timely basis through Form 8-K. Another institutional aspect of material contracts disclosures that is relevant to my research is that registrants can request confidential treatment of portions of material contracts pursuant to Rule 406 under the Securities Act of 1933 and Rule 24b-2 under the Securities Exchange Act of 1934. Registrants are required to seek and receive the SEC’s approval for confidential treatment, and the time granted for preserving confidentially rarely exceeds five years (Overdahl, 1991). In order to provide registrants with sufficient time for requesting confidential treatment, the Final Rule does not mandate the disclosure of the entire contract with the Form 8-K filing. As discussed above, the SEC does encourage registrants to file material contracts immediately as exhibits to Form 8-K filings, especially when they do not require confidential treatment. 71 APPENDIX B STEPS TO IDENTIFY MATERIAL CONTRACTS 72 This appendix explains the details of identifying the material contracts filed by a firm. For each of the NYSE/AMEX/NASDAQ firms in my sample period, I first download from EDGAR all the current reports, periodic reports, registration statements and any related amendment reports ever filed by the firm. Current report refers to 8-K. Periodic reports include lO-K, 10-Q, lO-KSB, lO-QSB, 10-K405, and 10-KSB40. Registration statements include S-l, S-2, S-3, S-4, S-8, SB-2, SC 13D, POS AM, 425, IO-IZB, and 10-12G. Second, within each filed report, I use a PERL program to search for a line with the string “EX-10” as the beginning of a material contract and the next “” as the end of the contract. This is because the EDGAR system always adds several head lines (e. g., EX-10, , , and ) on the top of each reported material contract to provide an index and summary for the associated contract. Third, if there is more than one material contracts found in a report, I assign index 1, 2, 3 to them according to the sequence of their appearance in the document. 1 also save each identified material contract as a separate file. All the special characters in the format of <. . .> and <&...>, which are used extensively in SEC XML format documents, are replaced with blanks. Any material contract filed in Form 8-K is labeled as 8-K disclosed. 73 APPENDIX C STEPS TO EXTRACT INFORMATION FROM MATERIAL CONTRACTS 74 This appendix explains the details of extracting the contract description, name/title, entry/amendment date, status of redaction, and contract type information from each saved material contract. Description I search for the head line starting with the string “” and save the information to the right of such a string as the description of the contract. This description will normally give brief information on the type of the agreement (e.g., Employment Agreement or Credit Agreement). Name/'1‘ itle Right below the EDGAR-system-generated head lines, the first line with certain key word such as “AGREEMENT”, “CONTRACT”, “PLAN”, etc in the content will generally be the title of the contract and I save this line as the name of the material contract. Entry/Amendment Date The entry/amendment date of an agreement can be specified in three different ways. First, it can be presented on a separate line below the title of the contract. An example is as the follows: CREDIT AGREEMENT by and between SOMERA COMMUNICATIONS, INC., a Delaware corporation and WELLS FARGO HSBC TRADE BANK, N.A. Dated as of February 9, 2001 Second, it can be disclosed by sentences in the first paragraph below the title. For example, it can take the form as either “THIS AGREEMENT is made and entered into as of the 15th day of November, 2001” or “THIS STOCK PURCHASE AGREEMENT (this 75 "Agreement"), dated as of December 20, 2001.” Third, it can be shown in the signature section on the bottom of the contract. For instance, it can take the form as “By: /s/ John Smith Date: lO/12/2‘OOI”. I accommodate all three ways of presentation with my PERL program. In addition, things can be a bit more complex for amendment agreements as the dates of the original agreement and all the subsequent amendments will all be mentioned. An example can be “THIS AGREEMENT was originally made and entered into as of the 12th day of July 1998, ..., as first amended on this 15th day of November, 2001”. My PERL program is flexible enough to capture the entry/amendment date of the last amendment. Status of Redaction I search for the string “confidential treatment” or “redacted” in the first 20 lines of the contract as the indicator of whether some portion of the contract has been redacted. This is because Rule 406(b) [17 CFR 230.406(b)] and Rule 24b-2(b) [l 7 CF R 240.24b- 2(b)] require that registrant clearly indicate within the material contract that the confidential part has been omitted from the publicly accessible version. Most of the firms who redact information will place such notification at the top of the document. An example is as the follows: CONFIDENTIAL TREATMENT REQUESTED Confidential Portions of this Agreement Which Have Been Redacted Are Marked with Brackets ([***]). The Omitted Material Has Been Filed With The Securities and Exchange Commission. SUPPLY AGREEMENT Contract Type Item 601 of Regulation S-K (and the comparable item of Regulation S-B) identifies the following as reportable material contracts: 76 0 Any contract that is critical to registrants’ business, such as significant agreements to sell products or services to a large customer, significant supply agreements, and licenses to use a patent, formula or trade secret, etc.; 0 Any material lease agreement relating to an important property described in the registrants’ registration statement or periodic reports; 0 Any contracts relating to the acquisition or disposition of any property, plant, or equipment whose transaction value exceeds 15 percent of the registrant’s consolidated fixed assets (as of the end of the most recent fiscal period); 0 Any contracts with security holders or underwriters, such as rights agreements, stock purchase or sale agreements, option arrangements, or voting share agreement covered by Regulation MD; 0 Any ancillary contracts relating to acquisition, liquidation, etc., that are not the actual merger agreement; 0 Any significant loan agreements, waivers, guarantees, and other debt-related contracts; and 0 Any management contracts, compensatory plans, and other arrangement agreements with any directors or any of the five most highly paid executives (identified in the proxy statement). Accordingly, I classify material contracts into eight types (including an “Other” category) based on the key words in their descriptions or titles. The table on the next page shows the details. Contract Type Key Words in Contract Description or Title Advertising, Advisory, Alliance, Collaboration, Commission, Competition, Construction, Consultation, Cooperation, Customer, Dealer, Development, Exploration, Facility, Factoring, Fee, Business- Franchise, Intellectual Property, Inventory, Joint Venture, License, Related Lobbyist, Loss Reinsurance, Maintenance, Manufacturing, Marketing, Mortgage, OEM, Operating, Outsource, Patent, Pricing, Processing, Product, Production, Rent, Research, Reseller, Royalty, Subcontract, Supplier, Supply, Tax, Tenancy, Trademark, 77 Transaction Lease-Related Lease, Leasing, Leaser, Leasee Asset Acquisition or Disposition Asset Purchase, Asset Sale, Asset Disposition, Real Estate, Escrow Equity-Related Equity, Lock up, Placement Agent, Preferred Stock, Rights, Security, Shareholder, Shelf Registration, Stock Issuance, Stock Purchase, Stock Sale, Stockholder, Subscription, Support, Underwrite, Vote, Voting, Warrant Business Acquisition, Affiliation, Limited Liability, Merge, Partner, Structure . . . . Reorganization, Restructuring, Separation, Takeover Change Debt-Related Assignment and Assumption, Assumption, Bond, Collateral, Commitment, Covenant, Credit, Custodial, Debenture, Debt, Deposit, Forbearance, Guarantee, Guarantor, Guaranty, Indenture, Interest Rate, Lender, Loan, Note, Pledge, Subordination, Trust, Waiver 401(k), Award, Benefit Plan, Bonus, Change in Control, Compensation, Defined Benefit, Defined Contribution, Director, Employ, Engagement, Executive, Incentive, Indemnity, Labor, Life Insurance, Management Continuity, Management Contract, Management Retention, Management Stability, Offer Letter, Officer, Employment- Related Omnibus, Option Grant, Pension, Performance Plan, Performance Share, Performance Stock, Profit Sharing, Promotion, Reimbursement, Resignation, Restricted Share, Retention, Retirement, Salary, Severance, Split Dollar, Stock benefit, Stock Plan, Union Other All the others 78 APPENDIX D DEFINITION OF VARIABLES 79 Dummy8K is the dummy variable indicating whether the firm filed at least one material contract through Form 8-K during the twelve-month period ending four months after the end of the fiscal year, zero otherwise. Percent8K is the percentage of material contracts that the firm filed through Form 8-K during the twelve-month period ending four months after the end of the fiscal year. ERC is the sum of the estimated coefficients (631 + £32) from the regression ABRET! = a0 1 of the current fiscal year. ABRET is measured as the difference between the buy-and-hold return of the firm and that of the CRSP value-weighted market index over a window spanning from 2 trading days after the prior quarter’s earnings release date to l trading day after the current quarter’s earnings release date. EARN is the quarterly earnings before extraordinary items (DA TA8) deflated by market capitalization as of the beginning of the current quarter. AEARN is the seasonally differenced quarterly earnings before extraordinary items deflated by market capitalization as of the beginning of the current quarter. This is the model suggested by Easton and Harris (199]).48 + a EARN t + aZAEARNt + 8t over the 20 quarters prior to the beginning AdeSQR is the adjusted R-squared from the regression specified in the definition of ERC. NumAnalyst is the number of equity analysts covering the firm as reported on I/B/E/S in the month immediately preceding the current fiscal year (if a firm is not covered by I/B/E/S, it is set to zero). InstOwn is the percent of shares held by institutions as reported on Spectrum by the end of the calendar quarter immediately preceding the current fiscal year (if a firm is not covered by Spectrum, it is set to zero). EquityIssue is the dummy variable indicating whether the firm issued equity during the twelve-month period ending four months after the end of the fiscal year as reported on SDC, zero otherwise. Dethssue is the dummy variable indicating whether the firm issued public debt during the twelve-month period ending four months after the end of the fiscal year as reported on SDC, zero otherwise. ’8 Using CRSP equally-weighted market index instead yields similar results. Earnings release is defined as either a press release or a periodic SEC filing through which earnings information is released to the public for the first time. I use earnings release date rather than earnings press release date because, subsequent to the calendar year 1999, COMPUSTAT would have included the SEC filing date as the “earnings announcement” date (RDQE) for firms that did not issue a press release or issued a press release later than the SEC filing date. See Li and Ramesh (2007a) for details. Following Lougee and Marquardt (2004), I also tried a model without the level term (i.e., EARN) as a robustness check and found similar results. 80 M&A is the dummy variable indicating whether the firm engaged in mergers and acquisitions during the twelve-month period ending four months after the end of the fiscal year as reported on SDC, zero otherwise. PCMargin is measured as the aggregated sales (DA TA12) divided by the aggregated operating costs (including cost of goods sold (DA TA41), selling, general, and administrative expenses (DA TA189), and depreciation, depletion, and amortization (DA TAI4)) in a particular industry (four-digit SIC CD code) for the fiscal year. LnPPE is measured as the weighted average gross value of the cost of property, plant and equipment (DA TA7) for a particular industry (four-digit SICCD code), weighted by each firm’s market share (identified by sales) for the fiscal year. IPIntens is the dummy variable indicating the membership in industries which likely have high intellectual property investment—the CRSP standard industrial classification code (SICCD) at the end of the fiscal year is 2833-2836 (Drugs), 8731-8734 (R&D services), 7371-7379 (Programming), 3570-3577 (Computers), 3600-3674 (Electronics), or 3810-3845 (Precise Measurement Instruments), zero otherwise. ROA is the net income (DA TA] 72) deflated by the average of the beginning and ending total assets (DA TA6) of the fiscal year. Loss is the dummy variable indicating whether the firm had a loss for the fiscal year (negative DA TA] 72), zero otherwise. LnMVE is the natural logarithm of the firm’s market value of equity at the end of the calendar year ending during the fiscal year (DA TA24*DA TA25). LnNumMC is the total number of material contracts filed by the firm within the twelve months window ending four months after the fiscal year end. PIN is calculated as the average of the four calendar-quarter Probability of Informed Trade measures downloaded from the personal website of Professor Stephen Brown, who calculated PIN according to the Easley et al. (1997) microstructure model. The four calendar quarters are identified as the calendar quarters the beginnings of which fall into the twelve-month period ending four months after the end of the fiscal year. MonthlyTurnover is measured as the mean monthly trading volume deflated by total shares outstanding during the twelve-month period ending four months after the end of the fiscal year. DollarDepth is measured using the TAQ quote files by keeping only the quotes that meet all of the following criteria: (1) quotes occurred on the NYSE, AMEX or NASDAQ (EX = “A”, “N” or “T”); (2) quotes were made under normal market conditions (MODE = 12); (3) quotes were made within the normal trading hours (09:30:00<=TIME<=16:00:00); (4) quotes were not aggregate ones (NMID is not “AA”, “AI”, “IA” or “II”); (5) the ask price is strictly higher than bid price; (6) the bid price is 81 positive; (7) the relative spread, calculated as (ask price — bid price)/((ask price + bid price)/2), is not higher than 20%. I first calculate the dollar depth of each quote as (BID * BIDSIZ + OF R * OFRSIZ) 2 value of the dollar depths of all valid quotes within each firm/trading day. The final DollarDepth variable is the average of the daily median dollar depths during the twelve-month period ending four months after the end of the fiscal year. and get the daily median dollar depth as the median NYSE is the dummy variable indicating whether the firm is traded on NYSE at the end of the fiscal year, zero otherwise. AMEX is the dummy variable indicating whether the firm is traded on AMEX at the end of the fiscal year, zero otherwise. LnPrice is the natural logarithm of the median price per share for the twelve- month period ending four months after the end of the fiscal year. DummyRedact is the dummy variable indicating whether the firm filed a request for confidential treatment on at least one material contract during the twelve-month period ending four months after the end of the fiscal year, zero otherwise. Compustat_Dethssue is the dummy variable indicating whether the firm issued any public or private debt during the fiscal year (non-zero DA TA] 1 1), zero otherwise. Hindex is the rank of the industries Herfindahl-Hirschman index on the Verrecchia and Weber (2006) replication sample. The index is the sum of the squared market share (identified by sales) of each publicly traded firm in a particular industry (two-digit SICCD code). 82 Table A1 Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Heckman Probit Regressiona First Stage Probit Second Stage Probit Regression Regression (DV=DummyMC) (DV=Dummy8K) Pred. Coeff. Pred. Coeff. Variables Sig (Z-stat) Sign (Z-stat) (l) (2) (3) (4) Intercept 0.483 -1 .194 (6.73) m (-5.57) '*' ERC — -0.003 (-2.38) *" Aab'RSQR — 0.038 (0.67) NumA nalyst ? -0.01 3 (-2.67) ..., InstOwn ? -0.277 (-3.83) *“ Equitylssue + 0.320 + 0.281 (12.97) "’* (4.21) m Debtlssue + 0.1 1 l + 0.054 (3.27) '“ (0.68) M&A + 0.186 + 0.167 (12.43) "” (3.99) “* PCMargin — -0.388 + 0.466 (-7.48) *"* (4.64) "" LnPPE ? 0.000 — -0.008 (0.07) (-0.97) IPlntens ? 0.007 — -0. 10 I (0.31) (-2.47) " ROA — -0.311 -0.137 (-l4.30) ‘“ (-2.58) *" Loss + 0.287 0.045 (15.92) "‘ (0.87) LnMVE ? 0.1 15 -0.082 (23.45) *** (-6.02) *“ LnNumMC 0.383 (14.23) *“ Coefficients and z-statistics on fiscal year indicator variables are suppressed. Wald test (x2(16)) 577.52 (p<0.001) Number of observations (DummyMC = 0/ 1) 13,136 (2,631 / 10,504) 83 Table A1 (cont'd) *, **, "*z p < 0.10, p < 0.05 and p < 0.01, respectively, two-tailed tests. z-statistics for the pooled regressions have been adjusted for heteroskedasticity and finn-specific clustering in the panel data. 21This table is based on a sample period from 2001 to 2003. All the variables except DummyMC are defined in Appendix D. DummyMC is the dummy variable indicating whether the firm filed at least one material contract during the twelve-month period ending four months afier the end of the fiscal year, zero otherwise. ERC , InstOwn , ROA have been winsorized at the top and bottom 1% of their respective distribution. Heckman probit regression is used to estimate the two-stage model with DummyMC as the first-stage dependent variable and Dummy8K as the second-stage dependent variable. Result on the first- stage selection model is presented in Column (2). Result on the second-stage determinants model is presented in Column (4). Fiscal year indicator variables are included in both models. 84 Table A2 Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Test after Controlling for Contract Typea Probit Regression After Controlling For Contract Type Pred. Sign (DV—Dummy8K) Coeff. Variables (Z-stat) (1) (2) Intercept -1 .360 (-7.28) "*' ERC - -0.003 (-2.08) ** AafiRSQR — 0.053 (0.86) anA nalyst ? -0.010 (-1.87) ' InstOwn ? -0. 178 (-2.29) *‘ Equitylssue + 0.309 (5.32) "‘ Debtlssue + 0.073 (0.86) M&A + 0.179 (4.75) *" PCMargin + 0.292 (2.82) *“ LnPPE — -0.004 (-0.43) lPlntens — -0. 1 16 (-2.65) *”* ROA -0.129 (-2.80) m Loss 0.089 (2.22) *" LnMVE -0.039 (-3.09) *“ LnNumMC 0.438 (21.77) m %BusinessMC -0.204 (-l.50) %LeaseMC -0.759 (-4.62) ”* %AssetAcquiDisposMC 0.967 (6.40) **" 85 Table A2 (cont'd) %EquityMC 0.988 (7.02) *“ %Structure(‘hangeMC 0.472 (2.46) ** %DethC -0.069 (-0.57) %EmploymentMC -0.844 (-7.08) "" Coefficients and z-statistics on fiscal year indicator variables are suppressed. 2 Pseudo R 0.174 Number of observations 10,504 *, **, “*2 p < 0.10, p < 0.05 and p < 0.01, respectively, two-tailed tests. z-statistics for the pooled regressions have been adjusted for heteroskedasticity and firm-specific clustering in the panel data. aThis table is based on a sample period from 2001 to 2003. %BusinessMC , %LeaseMC , %AssetAcquiDisposMC , %EquityMC , VoStructureChangeMC , %DethC , %EmploymentMC are the proportions of all material contracts that the firm filed during the twelve-month period that are Business- related, Lease-related, Asset Acquisition or Disposition-related, Equity-related, Business Structure Change-related, Debt-related, Employment-related, respectively. All other variables are defined in Appendix D. ERC , InstOwn , ROA have been winsorized at the top and bottom 1% of their respective distribution. Probit regressions are used to estimate the models with Dummy8K as the dependent variable. Fiscal year indicator variables are included in the model. 86 Table A3 Capital Market Implications of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Tests after Controlling for Contract Typesa DV=PIN DV=M0nth 1y Turnover DV=DolIarDepth Two-Stage Two-Stage Two-Stage Heckman Reg. Heckman Reg. Heckman Reg. Pred. (IV—Dummy8K) Pred. (IV-Dummy8K) Pred. (IV—Dummy8K) Sign Coeff. Sign Coeff. Sign Coeff. Variables (t-stat) (t-stat) (t-stat) (1) (2) (3) (4) (5) (6) Intercept 0.477 -0.094 -30.244 (16.77) m (-333) m (4.09) Dummy8K — -0.051 + 0.176 + 33.691 (-5.52) “’ (6.44) “" (2.38) ** NumAnalyst — 0.000 + 0.003 + 4.233 (-0.70) (3.88) ““ (8.89) “‘ InstOwn ? -0.028 ‘2 0.070 ? -47.998 (-8.95) *" (6.62) "* (-9.04) “‘ LnNumMC 0.002 -0.002 -2.598 (2.02) '* (-0.54) (-l.31) LnMVE - -0.038 + 0.025 + 25.864 (-4077) 1'" (10.70) “‘ (1361) '" NYSE -0.019 -0.111 18.199 (-10.28) m (-17.46) m (5.73) m AMEX 0.002 -0.050 35.761 (0.60) -8.49 *“ (10.020 “" LnPrice 0.016 0.005 1.008 (12.32) *“ (1.30) (0.34) %BusinessMC -0.005 0.027 -4.571 (-1.00) (2.10) “ (-0.76) %LeaseMC -0.008 0.048 -10.210 (-1.28) (2.94) *** (-1.98) ** %AssetA cquiDisposMC -0.016 0.047 -3 .801 (-2.31) “ (2.85) “* (-0.67) %EquityMC -0.01 1 0.027 1.329 (-1.93) * (1.99) ** (0.23) %SlructureChangeMC -0.010 0.016 1.289 (-1 .40) (0.88) (0.14) %DethC 0.003 -0.007 -4.091 (0.71) (0.68) (-0.91) %EmploymentMC -0.004 0.001 1.039 (-1.04) (0.1 l) (0.24) InvMills 0.027 -0.090 -16.279 (5.24) m (-6.01) *“ (-2.01) *' 87 Table A3 (cont'd) Coefficients and t-statistics on fiscal year indicator variables and industry (two-digit SICCD code) indicator variables are suppressed. , 2 Adjusted R 0.648 0.209 0.487 Number of observations 10,043 10,504 10,414 *, **, "*2 p < 0.10, p < 0.05 and p < 0.01, respectively, two-tailed tests. t-statistics for the pooled regressions have been adjusted for heteroskedasticity and firm-specific clustering in the panel data. a This table is based on a sample period from 2001 to 2003. %BusinessMC , %LeaseMC , %AsselAcquiDisposMC , %EquityMC , "/oStructureChangeMC , %DethC , %Employmem‘MC are the proportions of all material contracts that the firm filed during the twelve-month period that are Business- related, Lease-related, Asset Acquisition or Disposition-related, Equity-related, Business Structure Change-related, Debt-related, Employment-related, respectively. lnvMi/Is is the inverse Mills ratio calculated from the economic determinants model with Dummy8K as the dependent variable. All other variables are defined in Appendix D. InstOwn has been winsorized at the top and bottom 1% of its distribution. Two-stage Heckman regressions are used to estimate the models with Dummy8K as the independent variable. Industry indicator variables (based on two-digit SICCD code) and fiscal year indicator variables are included in all the models. 88 Table A4 Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Robustness Tests on Sub-Samplesa Probit Regressions (DV=Dummy8K) after E33321“; t- Dropping AAD Dropping Turn- or BSC-Related of-Month Pred. Related . Contracts Contracts Sign Contracts Coeff. Coeff. Coeff. Variables (Z-stat) (Z-stat) (Z-stat) (1) (2) (3) (4) Intercept -1.376 -1.515 -1.394 (-8.87) *" (-10.03) *" (-8.97) ‘“ ERC — -0.002 -0.003 -0.003 (-1.80) ' (-2.17) *" (-2.73) '“ AdeSQR - 0.053 0.029 0.019 (0.86) (0.48) (0.31) NumA nalyst ? -0.013 -0.012 -0.013 (-2.29) “ (-2.49) “ (-2.59) "‘ InstOwn ? 0203 -0.272 -0.256 (~2.46) ** (-3.51) *“ (~3.19) *“ Equilylssue + 0.303 0.341 0.3 17 (5.24) *‘* (5.95) *“ (5.58) *" Debt/ssue + 0.078 0.109 0.081 (0.86) (1.30) (0.93) M&A + 0.219 0.187 0.207 (5.64) **" (5.02) '** (5.39) *" PCMargin + 0.389 0.355 0.365 (3.56) '** (3.42) m (3.38) *“ LnPPE — -0.006 -0.007 -0.007 (-0.61) (-0.83) (-0.80) lPIntens — -0.102 -0.098 -0.1 13 (-2.27) ** (-2.28) “ (-2.58) *“ ROA -0.182 -0.l94 -0.l76 (-4.04) *** (-4.42) *“ (-4.06) "* Loss 0.083 0.131 0.078 (2.05) ** (3.34) *** (1.92) " LnMVE -0.048 -0.059 -0.065 (-3.73) *" (-4.74) ..., (-5.22) ”* LnNumMC 0.421 0.396 0.451 (21.11) *" (20.12) *“ (22.5) “"’ Coefficients and z-statistics on fiscal year indicator variables are suppressed. Pseudo R2 0.105 0.101 0.114 Number of observations 8,658 10,37] 9,61 1 89 Table A4 (cont'd) *, **, ***: p < 0.10, p < 0.05 and p < 0.01, respectively, two-tailed tests. z-statistics for the pooled regressions have been adjusted for heteroskedasticity and firm-specific clustering in the panel data. 2‘This table is based on a sample period from 2001 to 2003. All the variables are defined in Appendix D. ERC , InstOwn , ROA have been winsorized at the top and bottom 1% of their respective distribution. Probit regressions are used to estimate the models with Dummy8K as the dependent variable. Dropping Employment-Related Contracts refers to the sub-sample without any Employment-related material contracts. Dropping AAD or BSC-Related Contracts refers to the sub-sample without any Asset Acquisition or Disposition-related or Business Structure Change-related material contracts. 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E .000. ... 80.0-. E 80.0-.. ... 30.0-. :0... .00.... .00.... 08.00 000.00 000.00 .00.... 00.....- 03? .00... 000... 000... 0.8.... 3.280. m< 0.0.0... 92 Table A6 Capital Market Implications of Choosing Timely Disclosure of Material Contractsa DV=PIN DV=Monthly Turnover DV=DollarDepth Two-Stage Two-Stage Two-Stage Heckman Reg. Heckman Reg. Heckman Reg. Pr ed. (IV=Dummy8K) Pre d. (IV=Dummy8[Q Pred. (IV=Dummy8K) Si 11 Coeff. S' Coeff. S' Coeff. . g '8“ lg“ Vanables (t-stat) (t-stat) (t-stat) (1) (2) (3) (4) (5) (6) Intercept 0.473 -0.081 -33.076 (16.5) *** (-3.30) * (-1.19) DummyDLagl 0 — -0.044 + 0.158 32.215 (’5-39) ... (6.21) “* (2.44) ** NumAnalyst — 0.000 + 0.002 4.229 (-0.85) (3.71) m (8.78) m InstOwn ? -0.027 ? 0.066 -47.383 (-8.53) m (6.15) m (-8.92) 1* LnNumMC 0.002 -0.001 -2.881 (1.83) ' (-0.26) (-1.45) LnMVE - -0.038 + 0.025 26.032 (-40.59) m (10.52) *** (13.53) m NYSE -0.019 -0.114 18.790 (-9.83) '** (-17.54) “* (5.90) "* AMEX 0.002 -0.050 35.769 (0.58) (-8.43) *** (10.09) ”* LnPrice 0.016 0.004 0.853 (12.45) *‘* (1.13) (0.29) InvMills 0.022 -0.079 -15.534 (5.03) * (-573) m (2.12) " Coefficients and t-statistics on fiscal year indicator variables and industry (two-digit SICCD code) indicator variables are suppressed. Adjusted RZ Number of observations 0.646 9,915 0.202 10,373 0.485 10,286 *, **, ***: p < 0.10, p < 0.05 and p < 0.01, respectively, two-tailed tests. t-statistics for the pooled regressions have been adjusted for heteroskedasticity and firm-specific clustering in the panel data. aThis table is based on a sample period from 2001 to 2003. DummyDLag/O is the dummy variable indicating whether the firm filed at least one material contract withing 10 calendar days afier its event date during the twelve-month period. lnvMil/s is the inverse Mills ratio calculated from the economic determinants model with DummyDLaglO as the dependent variable. All other variables are defined in Appendix D. InstOwn has been winsorized at the top and bottom 1% of its distribution. Two-stage Heckman regressions are used to estimate the models with DummyDLagIO as the independent variable. Industry indicator variables (based on two-digit SICCD code) and fiscal year indicator variables are included in all the models. 93 Table A7 Determinants of Choosing Form 8-K over Other SEC Reports for Material Contracts Disclosure: Alternative Measures of Earnings Informativenessa Two Alternative All Four Measures Measures Pred. (DV=Dummy 810 (DV=Dummy8K) Sign Coeff. Coeff. Variables (Z-stat) (Z-stat) (2) (3) Intercept -1.5 83 -l .564 (~10.54) *"* (-10.4l) "' ERC -0.003 (-2.40) “ Aab‘RSQR 0.043 (0.71) Intangible 0.3 14 0.310 (3.25) m (3.22) "" SaleGrowth 0.065 0.061 (2.17) ’* (2.05) ** NumA nalyst -0.01 3 -0.01 3 (-2.68) *“ (-2.60) *“ InstOwn -O.282 -0.280 (-3.71) “"‘ (-3.68) "‘ Equitylssue 0.364 0.36 l (6.53) ”* (6.49) *“ Debtlssue 0.090 0.084 (1.10) (1.03) M&A 0.204 0.206 (5.58) m (5.64) '“ PCMargin 0.453 0.442 (4.33) “‘ (4.23) "‘ LnPPE -0.006 -0.007 (-0.72) (-0.80) lPlntens -0. 109 -0. 109 (-2.56) ** (-2.56) " ROA -0.l79 -0.l77 (-4.08) “* (-4.03) *" Loss 0.123 0.117 (3.20) m (3.05) ”* LnMVE -0.068 ~0.067 (-5.56) m (-5.48) *“ LnNumMC 0.401 0.400 (21.06) m (21.00) "* Coefficients and z-statistics on fiscal year indicator variables are suppressed. Table A7 (cont'd) 2 Pseudo R 0.107 0.108 Number of observations 10,398 10,398 *, **, “*z p < 0.10, p < 0.05 and p < 0.01, respectively, two-tailed tests. z-statistics for the pooled regressions have been adjusted for heteroskedasticity and firm-specific clustering in the panel data. aThis table is based on a sample period from 2001 to 2003. All the variables except Intangible and SaleGrowth are defined in Appendix D. Intangible is calculated as the intangible assets (DA TA33 ) deflated by the total assets (DA T A 6) at the beginning of the fiscal year. SaleGrowth is calculated as the change rate of the sales (DA TA 12) for the current fiscal year over that of the prior year. ERC , InstOwn , ROA have been winsorized at the top and bottom 1% of their respective distribution. Probit regression is used to estimate the model with Dummy8K as the dependent variable. Fiscal year indicator variables are included in both models. 95 BIBLIOGRAPHY Ajinkya, B., S. Bhojraj, and P. Sengupta. 2005. 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