Evidence That Management Discussion and Analysis (MD&A) is ... · Contemporary Accounting Research...

Evidence That Management Discussion andAnalysis (MD&A) is a Part of a Firm's

Overall Disclosure Package*

PETER M. CLARKSON, Simon Eraser University

JENNIFER L. KAO, University of Alberta

GORDON D. RICHARDSON, University of Waterloo

AbstractThe objective of this study is to investigate the role, if any, that management discussionand analysis (MD&A) plays in a firm's disclosure package. First, we present evidenceregarding the usefulness of MD&A. Our evidence is uniformly supportive of the view thatMD&A is a source of new and useM information and indicates that MD&A is used forfinancial analysis purposes by at least one significant user group, sell-side analysts, whoare members of the Toronto Society of Financial Analysts. We then provide evidence ondisclosure quality. The results reveal that, overall, MD&A disclosure quality varies withdisclosure stimuli similar to those found to influence disclosure choice in other disclosurechannels. However, a more refined analysis of the MD&A subcomponents reveals thatdiffercEt factors influence disclosure quality for those subcomponents. Taken together, ourresults are consistent with the notion that MD&A is a part of a firm's overall disclosure

A I'iBstar de la Securities and Exchange Commission (SEC) qui adoptait en 1980, auxEtats-Unis, de nouvelles exigences relatives au rapport de gestion (analyse par la direction

* Accepted by Dan Simunic. The authors wish to express their appreciation to the CGA-CanadaResearch Foundation for financial support; James Cole, CFA, Kelly Gray, CFA, and membersof the Toronto Society of Financial Analysts for providing management discussion and analysis(MD&A) disclosure scores; Mr. Philip Creighton, FCA, for providing Financial Post AwardsContest Data; and the Ontario Securities Conimission staff members for their assistance inobtaining data used in this study. We also wish to thank workshop participants at the AustralianNational University, Monash University, Simon Fraser University, the University of Queensland,the University of Sydney, University du Quebec a Montreal, the University of Alberta, theUniversity of British Columbia, the Australian Graduate School of Management, VictoriaUniversity (Wellington, New Zealand), the 1995 Asia-Pacific Finance Association Conference,and the Joint Accounting Workshop of SUNY at Buffalo and the University of Waterloo, andespecially Larry Brown, Jack Hughes, Seok Woo Jeong, Duane Kennedy, Ken Klassen, TerryO'Keefe, John Waterhouse, and T.J. Wong for their helpful comments. Finally, we acknowledgethe superb research assistance provided by Doug Dover, Toby Kilbreath, and Thomas Richard.

Contemporary Accounting Research Vol. 16 No. 1 (Spring 1999) pp.111-34 ©CAAA

112 Contemporary Accounting Research

de la situation financiere et des resultats d'expioitation), la Commission des valeursmobilieres de T Ontario (CVMO) a adopte des exigences analogues en cette matiere dansTenoned de politique n" 5.10 publie en novembre 1989. Comme l'indique Tenoned 5.10,I'objectif primordial de la CVMO est« de faire en sorte que les investisseurs disposent derenseignements plus pr6cis sur l'entreprise emettrice grace a la presentation d'ime analysecomplementaire et de documentation sous-jacente afin de permettre une comprehensionplus complete de la nature de l'entreprise 6mettdce, de ses activites et de ses perspectivesd'avenir »[traduction]. Selon cet 6nonc6, le rapport de gestion doit porter sur cinq eI6mentsprecis : I'exploitation, la situation financiere, la liquidite, I'information pr6visionnelle ainsique le risque et 1'incertitude.

La presente etude a pour objectif d'analyser le role que joue le rapport de gestion, lecas echeant, dans le programme d'information de l'entreprise. Les autetirs presententd'abord les faits etablis en ce qui a trait k l'utilite du rapport de gestion. Leurs constatationsviennent etayer sans equivoque rid6e selon laquelle le rapport de gestion est une sourced'informations k la fois nouveUe et utile et confirmer qu'il est employe a des fins d'analysefinanciere par au moins un groupe d'utiHsateurs iniportant, celui des analystes associes auxvendeurs qui sont membres de la Toronto Society of Financial Analysts (TSFA). Ayantetabli l'utilite du rapport de gestion, les auteurs font ensuite 6tat de la qualite deI'information qu'il contient afin de mieux etayer la notion selon laquelle le rapport degestion fait partie du programme global d'information de l'entreprise. Les resultats obtenuspar les auteurs revfelent que, malgr6 la quantity de facteurs differents qui influent sur laqualite de I'information Iivr6e dans les divers sous-elements du rapport de gestion, laqualite combinee de Finformation contenue dans le rapport de gestion vade en fonction destimuli a la presentation d'information semblables a ceux que rapportent les travauxexistants sur I'information facultative (par ex., Lang et Lundholm, 1993). De plus, unensemble de facteuts analogues r^gissent la presentation d'infotmatioti par les entreprisesde l'echantillon selectionn6 par les auteurs, dans les rapports de gestion et la presse. Cesresultats donnent a penser que I'information contenue dans les rapports de gesdon est regiede manifere comparable a 1'information publiee par I'intenn^diaire d'autres vehiculescourarrunent utilises et peut ainsi etre consideree comme faisant partie du programmed'information de l'entreprise.

Les donnees utilisees dans 1'etude ont ete obtenues avec l'aide de la TSFA. Pluspr6cisement, les auteurs ont d'abord demande de communiquer diiectement avec lesanalystes membres de la TSFA afin que ces demiers evaluent la qualite des informationscontenues dans les rapports de gestion des exercices 1991 et 1992 d'un echantillond'entrepdses, seiectionnees parmi les TSE 300, qu'ils devaient avoir suivies, et afin qu'ilsexpliquent leur perception des rapports de gestion. Afin de s'assurer que les analystesparticipants appliquent les memes cdteres, les auteurs ont mis au point une gdlled'evaluation des rapports de gestion avec l'aide des representants de la TSFA. Cette grilled'evaluation exigeait des analystes qu'ils evaluent s6parement chacun des cinq sous-elements des rapports de gestion, le maximum des points pouvant Stre attdbues (20 pourI'exploitation et 10 pour chacun des autres sous-elements) refietant 1'importance relativede chaque sous-flement. Les donnees de deux exercices successifs etaient necessaires, lesauteurs voulant analyser non seulement la qualite de I'information pour chaque exercice,mais egalement revolution de cette quaUte entre 1991 et 1992. Deuxiemement, les auteursont dernande de pouvoir communiquer avec l'ensemble des analystes membres du TSFAen vue de mener une enquSte visant a mieux cemer la fagon dont les analystes pergoiventl'utilite du rapport de gestion. Enfin, une evaluation de la qualite de I'information contenuedans les rapports de gestion de 1991 et 1992 a ete realisee par 10 analystes pour un

Evidence that MD&A is a Part of a Firm's Overall Disclosure Package 113

ediantillon de 55 entreprises, selectionnees parmi les TSE 300, repr6sentant 10 secteursd'activite definis en termes generaux a ia Bourse de Toronto. Trente-trois reponsesutiiisables ont ete obtenues dss analystes associes aux vendeurs, membres de laTSFA.

De maisiere plus precise, les conclusions des auteurs quant a l'utilite du rapport degtistio.n decouleni de trois perspectives. Premierement, comme Findique la partie A dutableau •, revaluation moyenne des anaiystes est respectivement de 37,07 et 38,06, sur unrasxifflum de 60, pour les rapports de gestion des exercices 1991 et 1992 examines, avecvn nivoau de signification de 1 pour cent dans les deux cas. fitant donne que l'hypotheserroHe, selon laqueiie ie rapport de gestion est per§u comme 6tant inutile, suppose uneevaiuatioii moyenne qui, statistiquemeni, ne peut etre distingufe de zero, ces resultats sontccnfornics a i'affirmation voulant que les analystes consid&rent le rapport de gestioncorame etant utiie. Pour etayer Tinterpretation qui veut que revaluation moyenne soit unemesure de Fatilite pergue, ies auteurs procedent a une enquete de rappel, aupres de huit desariiilystes evaluateurs, qui reveie I'e.iistence d'une correspondance reiativement forte entreleijrs evaluations et i'utilite du rapport de gestion et qui indique que la notion d'utilite se;:aoporte a rinfomiation snarginale au-dela de rinformation que Ton peut obtenir enpuisar,t a d'autres sources que le rapport de gestion.

Deuxiememeist, les resultats dim sondage dans le cadre duquel les auteurs ont posequatre quesdons generaies au sujet de rutilite qu'accordent au rapport de gestion tant lesanaiystes evaJuateurs qu'aplus grande echelle, les analystes associes aux vendeurs qui sontn:ie,mbrcs de la TSFA, indiquent que les deux groupes utilisent le rapport de gestion a des''ins d'aDiilyse financiere, csti.̂ nent que ie rapport de gestion foumit de rinformationnouvejle qu ils ne pourraient tirer ni de sources exterieures au rapport annuel, ni des etatsfinaiicrlers e- des notes atferentes, et croient que la quality de l'information contenue dansie rappon de gestion est confomie a celle de rinfoimation communiqoee par le truchementde vehriCiiies autres que le lappoit annuel. Les r6sultats de cc sondage sont presentes autableau 2.

TrolsismemeDt, ies resultats d'une analyse de contenu congue pour determiner si lerappcri de gestion est un medium permettant de communiquer rinformation en tempsopportun rcvsle que, pour 74.7 pour cent des entreprises de I'echantillon, bon nombred'ln'fonnatjons previsionneiies importantes relatives a Fexercice 1993 ont ete presenteesdans Is rapport de gestion de 1992 sans avoir ete communiquees auparavant dans la presse,des resuitafs qui, de toute evidence, ne sont pas conformes a la notion voulant que Ierappcrt de gestion soit peu revelateur.

Aiix iins de Fanaiyse empirique des determinants de la qualite de l'informationconterue dans ie rapport de gestion, les auteurs presentent sous forme de modele le degreda qualiie de i'information contenue dans le rapport de gestion pour 1991 et 1992 et•'svoiution de cstte qualite entre tcs deux annees, tant globalement que pour chacun desBous-eiements, Concurremment, iis appliquens a Ia fois le modele du degre de quality etcdu! dffl revolution a une mesure bien connue de l'information, les communiques de pressedisLincts, comme mecanisme de controle du caractere raisonnable des modeles relatifs ai'if!tOiiTiJii.ion facultative. Les variables explicatives utOisees dans leurs modeles s'inspirentdss trevaux de Lang et Lundhoim, 1993, et d'etudes connexes sur l'information quis-jggerent qae lc degre de qualite de rinformation foumie par une entreprise est relie ar existence de .stlmuii (soil ia perfomiance prevue dc l'entreprise (FP), l'intensite desactivkes cjs fmancement (FIN), la rotation au poste de chef de la direction (CEO) et]• occurrence d'evenements majeurs (ME)); les variables structurelles, notamment la taillede ]'er;treprise (SIZE), l'etendne de I'analyse subsfiquente (AF), les considerations relativesaii Tiia-'che da produit (ROE), '.'inscription a la cote (CL) et Fasymetrie de l'information


(RV et REQ ; et l'etendue de Finformation foumie selon les differents v6hicuies ac-cessibles (par ex., la presse (DPR)).

Les resultats de l'analyse de la qualite globale de Finformation contenue dans lesrapports de gestion, presentes au tableau 4, indiquent que la qualite de la presentation durapport de gestion presente un lien significatif et positif avec la performance deFentreprise, Fintensite des activites de financement, la taille de Fentreprise et lescotmnuniques de presse distincts, et un lien significatif et negatif avec Foccurrenced'evenements majeurs. Ainsi, le choix de la direction relatif k la qualite de Finformationcontenue dans le rapport de gestion parait 6tre influence a la fois par les stimuli et lesvariables structurelles, ainsi que par F6tendue de l'information foumie par l'intermediaired'un autre vehicule : la presse. Les rSsultats indiquent egalement que la variation deI'evaluation de Finformation contenue dans le rapport de gestion entre 1991 et 1992 est enrelation significative positive avec les variables de F evolution de la performance deI'entreprise, de Fintensite de ses activites de financement, de la rotation au poste de chefde la direction et des communiques de presse distincts, et en relation significative etnegative avec F evolution de la variable des evenements majeurs. Ces resultats donnent apenser que le changement dans I'evaluation des rapports de gestion est regi avant tout pardes facteurs qui fluctuent selon Fexercice. De plus, le if ̂ ajuste pour tenir compte dumodele de F evolution est beaucoup plus 6leve que les if ̂ ajustes des modules du degre dequality. II semblerait done que les modeles des auteurs expliquent mieux ce qui regitFevolution de la qualite de Finformation contenue dans les rapports de gestion d'annee enann6e qu'ils n'expUquent le degre de qualite de Finformation contenue dans ces rapports.

Les resultats de l'analyse pour chacun des cinq elements de Finformation contenuedans les rapports de gestion suggerent que la presentation d'information dans les diverssous-elements du rapport de gestion est influencee par differents facteurs. Par exemple,Fecart d'evaluation du sous-element exploitation ne pr6sente pas de lien significatif avecI'une quelconque des variables explicatives. Par consequent, il semblerait que le sous-element exploitation soit domine par les choix relatifs a Finformation, tels les definitionsdes activites sectorielles de Fentreprise, qui sont effectues et maintenus a long terme. AI'autre extreme, les analyses revelent que Fecart d'evaluation du sous-element infoimationprevisionnelle est en relation positive et significative avec revolution des variables deperformance de Fentreprise, d'intensite des activites de financement et de rotation au postede chef de la direction, et en relation negative et significative avec Fevolution de lavariable des evenements majeurs. Les resultats relatifs aux autres sous-elements se situententre ces deux extremes mais sont g6neralement faibles, dependants de deux ou troisvariables de stimuli de Fexercice courant, au niveau de signification de 10 pour cent. Cesresultats portent a conclure que certains sous-61ements du rapport de gestion se pretent plusque d'autres au texte «passe-partout».

Enfin, I'etude devrait interesser tant les enseignants que les responsables de lareglementation. Du point de vue des enseignants, elle Stablit que le rapport de gestioncontient de l'information nouvelle marginale qui est iitile aux analystes, un fait qui n'a pasete ceme dans les travaux recents sur les rapports de gestion (par ex., Barron, Kile etO'Keefe, 1999). Plus encore, I'etude suggere que la quality de Finformation contenue dansles rapports de gestion est ger^e de fajon analogue k Finfonnation transmise au moyend'autres vehicules de communication generalement acceptes. Enfin, Fanalyse plusapprofondie des sous-elements du rapport de gestion indique que ces divers sous-elementssubissent I'influence de diff&ents facteurs, ce que ne reveie pas Fexamen des mesures plusglobales de la qualite de Finformation contenue, par exemple, dans le rapport annuel (parex., Lang et Lundholm, 1993).


Du point de vue du responsable de la reglementation, la CVMO a partioipe activementa!'application de I'enonce de politique n° 5.10 et continue a s'y interesser. En s'appuyaatsur Fexameii annuel de conformity et les mesures d'application connexes, la CVMO aremis en question la quality de I'information contenue dans les rapports de gestion decertains inscrits. La constatation des auteurs seloa laquelle le rapport de gestion est uneimportaate scarce d'iaformation pour les anaiystes permet de croire que I'interet de laCVMO pour le rapport de gestion est justifie. Neanmoins, les evaluations effectuees parles analystes indiquent qu'il existe une variation considerable dans la qualit6 der information contenue dans les rapports de gestion, selon les entreprises. Les facteursceraes par Ies auteurs comme etant determinants de la qualite de Finformation contenaedans les rapports de gestion devraient aider les responsables de la reglementation a elaborerdes strategies de contrSle et a mettre sur pied de futurs programmes d'examen des rapportsde gestion. Ainsi, constatent les auteurs, revaluation de la qualite du sous-el6mentinformation previslonnelle des rapports de gestion varie directement avec la perfonnancea venir de!'entreprise. Ces resultats peuvent contribuer k expliquer pourqtioi le SEC a cibleles entreprises ea difficulte financiere pour examiner leura rapports de gestion (Kile, 1996).

1,Rixenjjy, there has been a irend by regulatory bodies toward encouraging greatercorporate disclosure in annual reports. One example is the Management Discussionand Aoaiysis (MD&A) requirements adopted by the American Securities andExchange Conmnssion (SEC) in 1980. Following the SEC, the Ontario SecuritiesCoiannistsiori (OSC) adopted similar MD&A requirements under Policy StatementNo. 5. iO in November 1989. As Policy No. 5.10 states, its primary objective is "toeohance investor understanding of the issuer's business by providing supplementalanalysis and background material to allow a fuller understanding of the nature ofac. issuer, its operations, and known prospects for the future." The policy dictatesthat MD&A should address five specific areas: operations, financial condition,liquidity, forward-looking information, and risk and uncertainty.

Nocwithstanding the emphasis placed on MD&A by the regulators in recentyears, little is known about disclosure in MD&A. The objective of this study is toinvestigate the role, if any, that MD&A plays in a firm's disclosure package. Webegin by presenting evidence regarding the usefulness of MD&A from threeperspectives. First, we ask members of the Toronto Society of Financial Analysts(TSFA) to score MD&A disclosure quality and comment on those scores throughfollow-up interviews for a sample of 55 Toronto Stock Exchange (TSE) 300firms.' Next, we conduct a broad-based survey of sell-side analysts to elicit theirviews regarding the usefulness of MD&A. Finally, we perform a content analysisdesigne<l to determine whether MD&A is a timely disclosure medium. Overall, theevidence is uniformly supportive of tlie view that MD&A is a source of both newand useful information and confirms that MD&A is used for financial analysispiorposes by at least one significant user group, sell-side analysts who are membersof the TSFA. This evidence is consistent with Barron, Kile, and O'Keefe 1999,who find, for a sample of SEC registrants, a negative association between MD&Acompliaince scores as assessed by the SEC, and analyst forecast error anddispersion IE the subsequent year.


We then provide evidence on disclosure quality to lend further support to theidea that MD&A is part of a firm's overall disclosure package. Our results indicatethat, while different factors influence disclosure quality for various MD&Asubcomponents, aggregate MD&A disclosure quality varies with disclosure stimulisimilar to those documented in the extant voluntary disclosure literature (e.g.,Lang and Lundholm 1993). In addition, a similar set of factors drive disclosure byour sample firms in MD&A and in the press. These results suggest that MD&Adisclosure is managed in a fashion similar to other well-known disclosure channelsand hence can be viewed as a part of the disclosure package used by the firm.

Our study should be of interest to both academics and regulators. From theacademic perspective, the study establishes that MD&A contains incremental newinformation that is useful to analysts, a fact that has not been made in theconcurrent MD&A literature (e.g., Barron et al. 1999). The finer analysis ofMD&A subcomponents provides insights not available from an examination ofmore aggregated measures of disclosure quality such as the annual report (e.g.,Lang and Lundholm 1993).

From the regulator's perspective, the OSC has been actively involved withand remains concemed about the application of Policy No. 5.10. On the basis ofannual compliance reviews and related enforcement actions, the OSC hasquestioned the quality of MD&A disclosuie by some registrants.^ Our finding thatMD&A is an important source of information to analysts suggests that the OSC'sinterest in MD&A is not misguided. Nevertheless, our analyst scores indicate thatthere is considerable variation in MD&A disclosure quality across firms. Thefactors we identify as determinants of MD&A disclosure quality should assistregulators in establishing monitoring strategies and conducting future MD&Areview programs.

The remainder ofthe paper is organized as follows. The data are described inSection 2. Evidence regarding the usefulness of MD&A is presented in Section 3.Results from the empirical analysis of factors that influence MD&A disclosurequality are presented in Section 4. A summary and conclusions are contained inSection 5.

2. DataIn contrast to U.S.-based studies (e.g., Lang and Lundholm 1993) that use analystscores of disclosure quality in the annual report and other channels, routinelyprovided by the Financial Analysts Federations (FAF), no such scores areavailable in Canada.^ We, therefore, approached the Toronto Society ofFinaneialAnalysts (TSFA) for their help in two ways. First, we requested direct access toanalysts who would evaluate the quality of the fiscal 1991 and 1992 MD&Adisclosures for a sample of TSE 300 firms that they had followed and who wouldprovide insight into their own perceptions of MD&A. Data from two contiguousyears were necessary because we wanted to analyze not only the quality ofdisclosure in each year, but also the change in disclosure quality between the twoyears. Second, we asked for broad-based access to the TSFA's member analyststo conduct a survey designed to gain further insights into the analysts' perceptionsof the usefulness of MD&A.

Evidence that MD&A is a Fart of a Finn's Overall Disclosure Package 117

Discussions with the TSFA indicated that it would be impractical to find morethan one analyst per TSE industry sector, and because of time constraints,participating analysts would be unable to score more than eight firms. We wantedat least five firms in each sector because, as will be discussed in the section ondeterminants of MD&A disclosure quality, our empirical tests are performed onan intraindustry basis. These considerations led us to restrict the sample to thelargest 100 of the TSE 300 firms in terms of market capitalization, subject tohaving a m;aximum of eight firms and a minimum of five firms in each sector. Thefinal sample consists of the 55 firms for which the TSFA analysts ultimatelyprovided MD&A disclosure quality scores for both 1991 and 1992. As can be seenfrom panel A of Table 1, the sample fimis are distributed across 10 broadlydefined TSE sectors.*

To ensure that the participating TSFA members worked with the same criteria,we developed ao MD&A scoring sheet with the help of TSFA officials. Thescoriog sheet required the analysts to separately score each of the five MD&AsubcGHiponents with the maximum attainable score (20 for operations and 10 foreach of the other subcomponents) refiecting the relative importance of eachsubcomponent as perceived by the TSFA. The measure of the analysts' perceptionof overall MD&A disclosure quality is simply the sum of the subcomponent scoresand varies between 0 and 60, with higher scores denoting better disclosure.^' ̂

Descriptive statistics for the 1991 and 1992 MD&A scores and for the changein MD&A scores between these two years are presented in panel A of Table 1, forthe overall sample and by TSE industry sector. Analogous descriptive statistics fortlie sutx:omponent scores for the overall sample are presented in panel B of Table1. These statistics reveal that there is a wide intraindustry range of assigned scoresacross the sample firms, at both the subcomponent level and overall. Further,despite the apparent consistency in the average MD&A disclosure quality scoresacross the two years, there is variation over time on a firm-by-firm basis. Thestatistics for the change in scores from 1991 to 1992 range from a decrease of 21to an increase of 14, with a standard deviation of 5.169. Finally, the results alsosuggest that the five subcomponent scores are not equally susceptible to change,with tlse scores for the operations subcomponent the most stable, and the scores forforward-looking information subcomponent the least stable.

3. Evidence on the usefulness of MD&AThe usefulness of MD&A is an unresolved issue in the academic literature and isclearly of importance to Canadian regulators. In this section, we present evidencerelating to the usefulness of MD&A from the scoring analysts, a broad-basedsurvey, and finally, a content analysis. Before presenting this evidence, we lay outconceptual arguments in support of and in opposition to the notion that MD&A isuseful.

Wliile some support exists in the literature for the usefulness of MD&A, apriori, it is not clear if this is indeed true. Opponents hold the view that MD&A ismostly boilerplate or irrelevant because the annual report is an extremely formaldisclosure channel that is vetted by the firm's lawyers and auditors. They arguethat management prefers to make the disclosures through less formal channels


TABLE 1

Distribution of MD&A disclosure quality scores for a sample of 55 TSE firms from1991 and 1992*

Panel A: Descriptive statistics for overall MD&A disclosure quality scoresSector # Firms 1992 1991 Change'''

Overall sample 55

1.0 Metal & mineral

2.0 Gold & silver mines

5.0 Consumer products

6.0 Industrial products/other

6.5 Industrial products/technology 5

6.7 Industrial products/chemicals

8.0 Transportation &environment services

9.0 Pipelines

10.0 Utilities

12.0 Merchandising

38.055(11.532)4 to 5826.833

(11.754)11 to 3736.000

(15.275)6 to 5141.667

(10.596)24 to 5239.000(8.485)

33 to 4540.800

(11.476)28 to 5840.400(7.668)

30 to 5032.000

(10.124)20 to 4640.000(7.071)

31 to 4741.875(4.257)

35 to 4741.571

(16.712)4 to 51

37.073(10.539)4 to 5428.333

(10.746)7 to 3536.857

(13.259)11 to 5239.833(9.326)

24 to 4942.000(4.243)

39 to 4540.600(9.633)

29 to 5440.200(6.140)

33 to 5029.800

(13.312)19 to 4840.500(1.291)

39 to 4236.750(3.196)

31 to 4039.857

(16.201)4 to 50

0.982(5.169)

-21 to 14-1.500(9.731)

-21 to 4-0.857(2.545)

-5 to 31.833

(1.722)0 to4

-3.000(4.243)

-6toO0.200

(8.899)-8 to 14

0.200(3.421)-3 to 5

2.200(4.765)

-2 to 9-0.500(6.856)

-10 to 55.125

(1.885)2 to 81.714

(1.704)0 to4


TABLE 1 (continued)

Panel B: Descriptive statistics for MD&A subcomponent disclosure quality scoresSubcomponent (max) 1992 1991 Change

OperatioBS (20)

Financial condition (10)

Liquidiry (10)

Forward-looidng information (10)

Risk and uncertainty (10)

13.673(5.081)0tol96.636(2.344)OtolO6.618(2.528)OtolO5.727(2.407)0to95.400(2.249)0to9

13.804(4.847)0 to l96.575

(2.282)0to96.511

(2.404)Oto95.553

(2.263)0to94.702

(2.321)0to9

-0.348(1.215)-15 to 50.022

(1.433)-5 to 20.174

(1.554)-5 to 50.130

(1.834)-7 to 30.544

(1.628)-7 to 5

Notes:* The amounts shown are the mean, standard deviation (in parentheses), and range.' The change is calculated as the 1992 score minus the 1991 score.

(e.g., the press) v^hftre they will be held less accountable. This view is consistentwith imp'sssions and anecdotal evidence that there are minimal changes in afirrr.'s MD&A di.sclosure over time.

Kcwsver. it can be argued that the very formality of the MD&A disclosurecn-annei i-acreases its credibility, thereby making MD&A the disclosure channelof choice. Specifically, since management will be held more accountable for what;•" discioses in a more formal channel, the costs of misrepresentation in MD&Av/iU be higher. Thus, the standard truth-telling assumptions of the voluntaryciscKosLire and signalling literatures are more likely to be met. The fact that thenrre's audiiors .review the MD&A lends further support to the truth-tellingitssurnption. This view draws support from two recent studies. First, Clarkson,Kac, and Richardson (1994) show that directional earnings forecast choices inMD&.h. are well described as a voluntary disclosure process, implying thatcecisicns made in this channel are aot arbitrary. Second, Bryan (1997) finds thatMD&A. Gi.sclosures are associated with one-step-ahead changes in sales, earnings,and otar.r financial statement variables, and that MD&A disclosures are contempo-raneou-sly as.sociated with stock returns, even after controlling for unexpectedeaiTiings. •lerice, prior access to this information would be valuable.

Evidence from the scoring analystsAs revealed in panel A of Table 1, the average analyst scores are 37.07 and 38.06out of a maximum of 60 for the 1991 and 1992 MD&A that they reviewed. The t-


statistics are 26.09 and 24.47, respectively, both significant at the 1 percent level.Since the null hypothesis that MD&A is perceived to be useless implies that theaverage score should be statistically indistinguishable from zero, these resultsappear to provide support for the assertion that the analysts view MD&A asuseful.' However, we asked analysts to score disclosure quality, not usefulness(see note 1). Thus, to gain support for the interpretation of the average analystscore as a measure of the perceived usefulness of MD&A to analysts, weconducted a follow-up survey with the eight of our sixteen analysts still available.The analysts were asked to respond to a series of questions using a seven-pointscale that was anchored at a value of zero by the null hypothesis (e.g., no usefulinformation, no correspondence) and at a value of six by the other extreme (e.g.,significant useful information, strong correspondence).

First, we asked the analysts to indicate the extent to which the MD&Adisclosure scores that they awarded reflected the degree of usefulness of theMD&A to them as financial analysts. Their responses ranged from 3 to 6 with amean of 4.47. The f-statistic on the mean response is 14.30, allowing us to rejectthe nuU of no correspondence.* This suggests that, while not perfect, there is arelatively strong correspondence between the disclosure scores and the notion ofusefulness. We next asked the analysts to indicate the extent to which usefulnessreflected incremental information beyond that available from sources other thanMD&A. The mean response is 4.43 and the ^statistic is 25.31, significant at the1 percent level, implying that the MD&A did provide incremental informationuseful to the scoring analysts.

To gain insight into the importance of MD&A relative to other disclosureoutlets, we posed four more general questions pertaining to the analysts' currentperceptions regarding MD&A. The results for these questions are presented in thefirst column of Table 2. First, we asked the analysts to indicate the extent to whichthey use MD&A for financial analysis purposes. The mean response is 4.63 andthe ^statistic is 10.05, significant at the 1 percent level. Second, we asked theanalysts to indicate the extent to which MD&A provides new information usefulfor financial analysis not available from sources outside the annual report. Themean response is 3.88 and the ^-statistic is 11.06, also significant at the 1 percentlevel. We then asked the analysts to indicate the extent to which MD&A providesnew information useful for financial analysis that is not available from thefinancial statements and footnotes. The mean response is 4.25 and the f-statisticis 9.38, again significant at the 1 percent level. This 4.25 mean response value ishigher than tlie mean response value of 3.88 for the preceding question, suggestingthat M D & A provides more useful incremental information relative to the rest ofthe annual report than relative to what the analysts already know from sourcesoutside annual reports. Finally, we asked the analysts to indicate the extent towhich they believe MD&A disclosure quality is consistent with the level ofdisclosure in other non-annual report channels. The mean response is 4.38 and thef-statistic is 10.42.

To gain further insights into the scoring analyst responses to question 1 (over-all usefulness) and question 2 (incremental new information), we also conducted

Evidence that MD&A is a Part of a Finn's Overall Disclosure Package 121

ScodngAnalysts(n = 8)

4.625*(1.301)3.875*

(0.992)

RespondentsSell-SideAnalysts(n = 33)

4.242*(1.601)3.879*

( l . l l i )

;-value

0.596

-0.009

4.000*

(1.000)

3.667*(1.242)

0.561

1.367

TABLE 2Results for a survey questionnaire regarding MD&A usefulness*

Question

1) To what extent do you use MD&Afor financial analysis purposes?

2) To what extent does MD&A generallyprovide new information useful forfinancial analysis that is not availablefrom information sources outside theannual report?

3) To what extent does MD&A provide 4.250*new information useful for financial (1.282)analysis that is not available from in-formation contained in the financialstatements and footnotes?

4) Ba^ed on yoarexpedence, is the firm's 4.375^MI3<&A disclosure quality consistent (1.187)with tlie level of disclosure in othernon-annual-report channels?

Notesj* The amouBts shown are the mean and standard deviation (in parenthesis). The seven-point

scale ranged from zero (i.e., no useful information, no relationship) to six (significantuseful information, very consistent).

f-values for the differences between the mean responses for the scodng analysts and the meanresponse for the sample of sell-side analysts.

* Significant at the 1 percent level.

follovi'- ap telephone Intei-views with them. During these interviews, the analysts in-dicated that there are indeed nonstale disclosures in MD&A, especially in theforwiird- looking area. The examples they offered include capital spending plans anddirectiona! forecasts by segment, and are similar to those identified in our contentanalysis. However, according to the analysts, new information, while important, isaoi the only aspect to .VID&A usefainess. MD&A is also useful to the analystsbecaa&e It gives them convenient access to detailed and cunent information in oneplacf,, and because it corroborates previous disclosures made by managementduring the year, Finally, the analysts pointed out that, while they do have otheriiifonoation sources (e.g., direct access to management), MD&A can be particularlydssfii! fer nsw companies about whom little information is available elsewhere.

Re.ss.lis front a broad-based surveyTo ascertain if the attitudes expressed by the scoring analysts (all sell-side) towardMD&A cars be generalized to Ihe population of sell-side analysts who are members


of the TSFA, we mailed a total of 416 survey questionnaires to firms that weremost likely to employ sell-side analysts. Of the 53 responses received, 20 wereunusable because the analysts either were clearly buy-side, did not indicate thenature of their work (sell- or buy-side), or provided incomplete answers to our foursurvey questions, leaving us with 33 usable responses.' The questions we posedwere the same four general questions asked of the scoring analysts to gain insightinto the importance of MD&A relative to other disclosure outlets.

The results, presented in the second column of Table 2, indicate that all meanresponse values are again significantly different from zero at the 1 percent level.As revealed in the third column of Table 2, there are no significant differencesbetween the mean responses of the scoring analysts and those of the broaderaudience of sell-side analysts. Thus, the views of the broader audience of sell-sideanalysts regarding the roles and usefulness of MD&A are consistent with those ofthe scoring analysts.

Results from the content analysisIn this subsection, we discuss the results of a content analysis that provides directevidence that MD&A contains nonstale disclosures and thereby serves tocorroborate the analyst survey evidence presented above. We analyze the specificcontent of MD&A and search for nonstale disclosures given what was disclosedin the press in the prior year. To keep the task manageable, we restrict ourattention to forward-looking information about fiscal 1993 appearing in the 1992MD&A and in the press during the 12-month period preceding the completion ofthe MD&A (i.e., the signing of the annual report). We use the 91 firms for which1992 MD&A disclosure quality scores are available (see note 4) to maximizesample size.^°

For the content analysis, we compared specific fiscal 1993-related disclosuresin the fiscal 1992 MD&A to specific 1993-related disclosures appearing in thepress during the previous 12 months. The analysis reveals that for 68 of the 91sample firms (74.7 percent), there were significant forward-looking disclosuresabout fiscal 1993 presented in the 1992 MD&A that had not previously beendisclosed in the press. Although highly judgmental in nature, the results are clearlyinconsistent vwth the notion that MD&A is largely stale. The most frequentlyappearing forward-looking disclosures in MD&A are overall or segment-by-segment directional forecasts, capital spending plans, major financing initiatives,major cost reduction, restructuring, or reorganization plans, the signing of majorcontracts or the adoption of new product lines, and order backlog information.This list is consistent with examples cited by the analysts we surveyed.

4. Determinants of MD&A disclosure qualityThis section presents results of empirical analyses designed to provide insightsinto factors that potentially influence management's choice of MD&A disclosurequality, at overall and the subcomponent levels. Using analyst scores as measuresof disclosure quality, we model the level of disclosure quality for 1991 and 1992and the corresponding change between these two years for the 55 TSE 100 firms


for which these scores are available for both years. The explanatory variables usedin our models follow from Lang and Lundhoim 1993 and related disclosure studiesthat suggest that a firm's level of disclosure is related to the presence of currentstimuli, such as expected firm performance (FP), level of financing activity (FIN),changes in senior management (CEO), and the occurrence of major events (ME);structinral variables, including firm size (SIZE), extent of analyst following (AF),product market considerations (i?OJF)," listing status (CL), and informationasymmetry (RV and REQ; and the extent of disclosure through alternativechannels, such as the press (DPR).

The structural equation we employ to explain the level of MD&A disclosurequality is:

Yo + Yi

j , +

Y2 PI^,, + Y3_, + y,RV,, +

+ SIZEj, +

j , + e,j = 1,..., 55 (1)

where MDA, (t ~ 1991, 1992) is the overall MD&A disclosure quality scoreassessed by the members of the TSFA and the explanatory variables (predictedsign of association in jJarenthesis) are measured as follows:

FP (+) A (0,1) variable with a value of 1 for firms with "good news" and 0otherwise (Lang and Lunholm 1993). A firm is classified as having"good news" if the firm's realized net income for the next fiscal year(E,^{) exceeds the firm's most recently realized net income (i^)-'^

FIN (+) The amount of equity financing raised by the firm during period t +1, expressed as a percentage of total assets (Lang and Lundhoim1993)."

CEG (-I-) A (0,1) variable with a value of 1 if a change in the firm's CEOoccurred dining fiscal period t and 0 otherwise (Gibbins, Richardson,and Waterhouse 1990).

M.E {+) A (0,1) variable with a value of 1 for firms with at least one majorevent and 0 otherwise (Healy, Palepu, and Sweeny 1994). A majorevent is identified by reading news articles (excluding press releases)appearing in the Lexis/Nexis database for the period between whenannual reports of periods f - 1 and t are signed by management. Anevent is coded as major if it accoanted for at least 20 percent of thetotal articles.'''

SIZE (+) The natural logarithm of the firm's total assets as identified in theperiod t annual report (Lang and Lundhoim 1993).

AF (+) The average number of analysts following the firm during fiscalperiod t as indicated on the Canadian International Brokers EstimateSystem (IBES) tapes (Botosan 1997).

ROE (+) The firm's return on equity over the five-year period prior to fiscalyear t (Hayes and Lundhoim 1996).

CL (+) A (0,1) variable with a value of 1 if the firm was cross-listed on aU.S. exchange in period / and 0 otherwise (Firth 1979).


RV (+) The standard deviation of market-adjusted annual returns over thefive-year period prior to fiscal period t (Lang and Lunholm 1993).

REC (-) The correlation between annual earnings and annual market-adjustedreturns over the five-year period prior to fiscal period t (Lang andLunholm 1993).

DPR (+) The number of distinct press releases issued by the firm during fiscalperiod t (Gibbins et al.l990).

Table 3 presents a descriptive profile of the sample firms along the dimen-sions of the selected explanatory variables for 1991 and 1992. As can be seen, thesample is broadly distributed along all dimensions. In addition, the descriptivestatistics suggest that there is relatively little difference between the 1991 and 1992distributions for each variable.

In addition to the levels model, we also consider a model that seeks to explainthe change in MD&A disclosure quality between 1991 and 1992. As explained inHealy et al. 1994, a changes specification is a robustness check for any bias inlevels models due to omitted variables. The form of this changes model is asfollows:

AMDAJ = 6g + 6, AFPJ + 62 AFINJ + 63 ACEOJ + 64 AMEJ + 65

+ d^ADPRj + Uj j = 1,..., 55 (2)

All variables are measured as the difference between their values for the 1992 and1991 MD&A equations. Remaining variables from equation (1) (i.e., SIZE, ROE,CL, RV, and REC) have been omitted because they do not vary in any measurableway between these two years.

Since each TSE sector was evaluated by a different analyst, we follow theapproach adopted in Lang and Lundholm 1993 by performing the analyses on anintra-industry basis. In particular, all dependent and independent variables exceptfor the dichotomous ones are industry-adjusted by subtracting the industry mean.'^For the changes model, we first calculate the change in variables, as explainedabove, and then subtract the industry mean change. The empirical analyses forboth the levels and the changes models are based on the industry-adjustedvariables and tests should, therefore, be interpreted as explaining intra-industryvariation.'*

MD&A disclosure quality modelsTable 4 presents the results for the overall MD&A disclosure quality models. Theresults for the 1992 and 1991 levels models, appearing in the first two columns,are qualitatively identical and indicate that MD&A disclosure quality is signifi-cantly and positively related to firm performance, level of financing activity, firmsize, and distinct press releases all at the 10 percent level, and significantly andnegatively related to the occurrence of major events at the 5 percent level. The t-values on the coefficients for these variables for the 1992 model, for instance, are1.841, 1.972, 1.906, 1.854 and -2.202, respectively. The adjusted R \ are 0.180


TABLE 3Descriptive statistics for a sample of 55 TSE firms from 1991 and 1992*

Panel A: ContiHUOus measuresVariable

Financing activity {FIN)

Firm size {SIZE) ($ millioos)

Analysts following {AF)

Prodact market {ROE)

Return variability {RV)

Retom-earningscorrelation {REQ

Distinct pressreleases {DPR)

Panel B; Dichotomous variables

Variable

Firm performance (FP)CEO turnover {CEO)Major event (M£)Listiflg status {CL)

1992

0.050(0.107)36.614

(66.487)12.182(7.640)0.035

(0.096)0.260

(0.492)0.166

(0.541)30.436

(27.926)

Proportion of 1

1992

0.6180.1460.1820.455

1991

0.039(0.129)34.143

(68.010)11.429(7.068)0.031

(0.078)0.288

(0.523)0.180

(0.509)27.273

(29.698)

's

1991

0.5640.1090.2180.436

Notes:* The way in which each of the variables is measured is described in the section on determinants

of MD&A disclosure quality.For the continuous variables, the amounts shown are the mean and standard deviation (inparentheses).

and 0.216 for the 1992 and 1991 models, respectively. All remaining variables inboth models are insignificant.

Tfiese results suggest that both current stimuli (i.e., firm performance,financing activity, and major events) and structural variables (i.e., firm size)influerice MD&A disclosure quality. In addition, MD&A disclosure quality isrelated to the extent of disclosure through an alternative channel— t̂he press. Whileour results on firm performance, financing activity, and firm size are consistentwith Lang and Lundholm 1993, the lack of significance on the return variabilityand retams-eamings correlation measures is in contrast with their findings.Further, although the analyst following and product market variables are insig-nificant, the positive sign of the analyst following coefficient is consistent withBotos£tn 1997 who finds greater annual report disclosure by more heavily followed


TABLE4

Results for the MD&A disclosure quality score models for a sample of 55 TSE firms*

Variable

Constant

Firm performance

Financing activity

CEO turnover

Major event

Firm size

Analyst following

Product market

Listing status

Return variability

Retum-eamingscorrelation

Distinct press releases

Adjusted R^

1992 MD&AScore

2.274(0.425)0.945*

(1.841)15.045*(1.972)1.329

(0.673)-4.997*

(-2.202)14.686*(1.906)0.044

(0.216)-0.110

(-0.353)1.262

(0.743)-1.106

(-0.862)-1.246

(-0.680)0.053*

(1.854)0.180

Dependent Variable

1991 MD&AScore

1.383(0.715)1.282*

(1.934)12.232*(1.908)2.700

(1.196)-5.395*

(-2.481)12.360*(1.730)0.116

(0.620)-0.377

(-0.275)1.129

(0.829)-0.893

(-0.670)-1.150

(-0.438)0.072*

(2.007)0.216

Change inMD&A Score

0.833(0.904)1.391*

(2.209)16.446*(2.311)0.460*

(1.735)-3.904*

(-2.146)—

0.070(0.527)

—

—

—

—

0.095*(1.832)0.477

Notes:* For the 1992 MD&A models, the variables are measured as follows:

Significant at the 5 percent level.Significant at the 10 percent level.

MD&A — the 1992 MD&A score as assessed by the analysts, the dependent variable.FP = firm performance, captured by a dummy variable based on the difference between the

firm's realized earnings for 1993 (E^^^) and for 1992 (E^^. If (£15,3 - fii,,^) > 0,then FP=l, otherwise FP = 0.

FIN = financing, the amount of equity raised by the firm during fiscal 1993 expressed as apercentage of total assets.

CEO = CEO turnover is a dummy variable set equal to 1 if the firm's CEO changed during1992.

ME = the major event dummy variable, set equal to 1 for firms which experienced at leastone major event during 1992.

AF = the extent of analyst following, measured as the average number of analysts followingthe firm during 1992.


TABLE 4 (continued)

SIZE = firm size, measured by the natural logarithm of the finn's total assets identified in the1992 annual report.

ROE = product market competition, me^ured as the firm's average five-year return onequity.

CL = the listing-status dummy variable, set equal to 1 for firms that were cross-listed on aU.S. stock exchange in 1992.

RV - return variability, measured as the standard deviation of market-adjusted annual returnsand annual market-adjusted returns over the five-year period prior to 1992.

REC — returns-earnings correlation, measured as the correlation between annual earnings andannual market-adjusted returns over the five-year period prior to 1992.

DPR = the press release variable, measured as the number of distinct press releases issued bythe firm during fiscal 1992.

For Ae 1991 MD&A model, the variables are measured in a corresponding fashion. For thechanges model, all variables are measured as the difference between the value of thevariables in each of tlie levels models, f-values are reported in parentheses.

firms, :md the negative sign of the product market coefficient is consistent with thenotion that firms enjoying grefiter abnormai profits provide more aggregated (andheiice iess informative) disclosu..ve in an attempt to conceal the source of theirproiitabiiity (Hayes and Lundholm 199{S). Finally, while significant, the negativesigr on the major-events variable is contrary to predictions. However, since theMD&A disclosure scores reflect the joint mapping of disclosure quality and anal-y??. expectations, we conjecture that the negative coefficient may reflect disap-poicTmeiii on the part of analysts over the level of disclosure by firms that haveexperienced major events. This conjecture is supported by written narrativesprovided by the scoring analysts.

;Results for the changes model in equation (2) are presented in the thirdcoiu.Tin of Table 4. As is evident, the change in the MD&A disclosure scores from1991 to 1992 IS significantly and positively related to the change in the firmperfcjnnance, levei of finanxing activity, CEO turnover, and distinct press releasevariables, and significantly and negatively related to the change in the majoreverits v.^riab]e. These results suggest th.at die change in MD&A score iS driven byfactc5t? ihat change from period to period. The changes model's adjusted R^ at0/47'"' is 'jonsiderably higher than the adjusted i?^s of the two levels models. Thus,i: would appear that our models are more successful in explaining what driveschaiAgcsi h':, MD&A disclo.sure quality from year to year than in explaining the levelof MD&.A. disclosure quality.

Press -i-ekase modelsAs a reasonableness check of our voluntary disclosure models, we also run bothtfcfc le-veLs and changes models on a well-known measure of disclosure, distinctpress releases (DPR). For this analysis, the number of distinct press releases (DPR)and ?be change in the number of distinct press releases (ADPR)) become thedspendent variable and the MD&A disclosure scores (MDA) and the change in theMD&.'̂ v disclosure scores (AMDA) become explanatory variable in the pressreieai;e versions of equations (1) and (2), respectively."


The results for the 1992 and 1991 press release levels models, presented in thefirst two columns of Table 5, are similar to those for the MD&A models in manyrespects. For example, the number of distinct press releases issued by a firm is alsosignificantly and positively related to firm performance, level of financing activity,and firm size. For both years, firm performance and level of financing activity aresignificant at the 10 percent level, and firm size at the 1 percent level. However,in contrast with the MD&A levels models, the number of distinct press releasesissued by a firm is significantly and positively related to the occurrence of a majorevent, analyst following, and listing status. The f-values for these variables aresignificant at the 5 percent, 1 percent, and 10 percent levels, respectively, for bothyears. Further, while the sign on the coefficient of the MD&A disclosure score ispositive, it is insignificant in both models. The significance of DPR in the MD&Amodels and the lack of significance of MD&A in the press release models is notunexpected given that DPR precedes MD&A in chronological time. AU remainingvariables are insignificant. The adjusted R\ for the 1992 and 1991 press releaselevels models at 0.633 and 0.682, respectively, are considerably higher than theadjusted R^s for the corresponding MD&A models.

The results for the press release changes model, presented in the third columnof Table 5, are also similar to the corresponding MD&A changes model. Specifi-cally, the change in the number of distinct press releases issued by a fima firom 1991to 1992 is significantly and positively related to the change in the firm performanceand level of financing activity variables at the 5 percent level, the CEO turnovervariable at the 10 percent level, and the major events variable at the 1 percent level.Again, the results on the first three are consistent with those for the MD&A changesmodel, whereas the sign on the major events variable is opposite to that in theMD&A changes model. The adjusted if for the press release changes model, 0.449,is close to the corresponding metric (0.477) for the MD&A changes model.

The levels and changes results for the DPR model are similar to thosepreviously documented in the voluntary disclosure literature and suggest that ourempirical models and choice of proxies are reasonable. While some differencesexist in the results for the levels models, the results for the changes model are,broadly speaking, similar to those for the MD&A changes model. This implies thatchanges in disclosure in each channel respond to a similar set of stimuli and thatthe disclosure channels are complements.

MD&A subcomponent score modelsWe also conduct an analysis for each of the five MD&A disclosure areas to see ifdifferent factors infiuence disclosure across subcomponents. For this purpose, wemodify equation (2) by replacing the change in overall MD&A score with thechange in each of the five subcomponent scores.'* Results for the MD&Asubcomponent changes models (not reported in a table) are, on balance, consistentwith inferences drawn from panel B of Table 1. The change in the operationssubcomponent score is not significantly related to any of the explanatory variables,a result that is not unexpected given the stability of disclosure in this area. It wouldappear that the operations subcomponent is dominated by disclosure choices, such


TABLE .5Resttlts for the press release regression models for a sample of 55 TSE firms*

Variable

Constant

Firm performance

Financing activity

CEO tumover

Major event

Firm size

Analyst following

Product market

Listing status

Return variability

Retum--eamings corr

MD&A score

Adjusted R^

1992 PressReleases

-3.402(-0.797)

3.358*(1.783)1.134*

(1.904)5.290

(0.836)10.472^(2.318)9.466'*'

(8.963)1.963^

(2.953)-2.470

(-0.205)7.399*

(1.747)-2.266

(-0.505)-0.118

(-0.280)0.328

(1.226)0.633

Dependent Variable

1991 PressReleases

-4.378(-0.134)

3.543*(1.843)0.986*

(1.839)6.188

(1.319)11.795^(2.180)8.925'''

(7.803)2.236'̂

(2.851)-2.207

(-0.487)5.572*

(1.775)-1.776

(-0.441)-0.268

(-0.435)0.379

(1.185)0.682

Change inPress Releases

-3.921(-0.755)

4.822^(2.170)0.872^

(2.160)8.112*

(1.886)8.969*

(3.621)—

4.310(0.243)

— •

—

—

—

0.307(1.478)0.449

Notes:* For the 1992 press release iviodei. the vadabies are measured as foUows:

Significant at the 1 percent level.* Significant at the 10 percenc levsi.^ Significant at the 5 percent Isvei.DPR ~ the dependent vaviatate. <he number of distinct press releases issued by the firm during

fiscal 1992.FP - firm peiformance. captured by a dummy variable based on the difference between the

firm's realized siuTiings for 1993 (E,^) and for 1992 (E.^. If (S,,,, - £,9,j) > 0, thenFJP = 1, otherwise FP •= 0.

FIN = financing, the amount cf equity raised by the firm during fiscal 1993 expressed as apercentage of total asset.').

CEO = CEO tumover, measured by a dummy variable set equal to 1 if the firm's CEO changedduring 1992.

ME = the major-event ilummy variable, set equal to 1 for firms that experienced at least onemajor event diirir-g •992.


TABLE 5 (continued)

AF = the extent of analyst following measured as the average number of analysts following thefirm during 1992.

SIZE = firm-size, measured by the natural logarithm of the firm's total assets identified in the1992 annual report.

ROE = product market competition, measured as the iirm's average five-year return on equity.CL = the listing-status dummy variable, set equal to 1 for firms that were cross-listed on a U.S.

stock exchange in 1992.RV = return variability, measured as the standard deviation of market-adjusted annual returns

and annual market-adjusted returns over the five-year period prior to 1992.REC = returns-earnings correlation, measured as the correlation between annual earnings and

annual market-adjusted returns over the five-year period prior to 1992.MD&A = the MD&A score assessed by the analysts. For the 1991 press release model, the variables

are measured in a corresponding fashion. For the changes model, all variables aremeasured as the difference between the value of the variables in each of the levelsmodels, /-values are reported in parentheses.

as the firm's segment definitions, that are made and adhered to for the long term.At the other extreme, panel B of Table 1 impHes that the forward-looking sub-component is the least stable across time and involves time-varying disclosurechoice (e.g., upcoming earnings performance). This finding suggests that changesin such scores should load on current period stimuli. Consistent with thisprediction, the analyses indicate that the change in the forward-looking informa-tion subcomponent score is positively and significantly related to the change in thefirm performance and financing activity variables at the 5 percent level, positivelyand significantly related to the change in the CEO turnover variable at the 10 per-cent level, and negatively and significantly related to the change in the major eventvariable at the 5 percent level. The results for the other subcomponents lie in be-tween these two extremes, but are generally weak, loading on two or three currentperiod stimuli variables at the 10 percent level. These results lead us to concludethat some subcomponents of MD&A are more prone to boilerplate than others.

5. Summary and conclusionsThe objective of this study has been to investigate the role, if any, that MD&Aplays in a firm's disclosure package. First, we present evidence regarding theusefulness of MD&A. Our results are uniformly supportive of the view thatMD&A is a source of both new and useful information, and indicate that MD&Ais used for financial analysis purposes by at least one significant user group, sell-side analysts who are members of the Toronto Society of Financial Analysts. Wethen undertake an empirical analysis designed to provide insight into factors thatpotentially infiuence management's choice of MD&A disclosure quality. Theresults reveal that MD&A disclosure quality varies with disclosure stimuli thatinfluence disclosure choice in other disclosure channels. Taken together, ourresults are consistent with the notion that MD&A is a part of a firm's overalldisclosure package.

From the academic perspective, the study establishes that MD&A containsincremental new information that is useful to analysts, a fact that has not been


nade -ri the MD&A literature. Furrhsr, this study suggests that MD&A disclosurequality is managed in a fashion similar to other wsU-accepted disclosure channels.Finariy, the analysis reveals that the various subcomponents of MD&A arei;ntlaeni';5(.; by dirterent factors, an insight not previously available in the disclosureH'ermire.

Q\r: results should be of interest to the regulators, given their expressed:.OT!.ceT.LiS ibout deficiencies in MD&A. The finding that MD&A is a source ofinformation ta analysts suggests that the regulators' interest in MD&A is notniiigulrfed. Kevejiheiess, our analyst scores indicate a variation in MD&Adisclosijre quaJily across lirnis and the results of our empirical analysis may assistregu].ators in establishing their monitoring strategies. For example, we documenttba?: the fcrward-looking information subcomponent of MD&A quality scores varydirectly with upcoming firm peiformance. This may help explain why the SEC hastargeted tlnancially distressed iinuh for review of their MD&A (Kile 1996).

1. iai-ialiy, v/e asked the analysts to score MD&A disclosure quality, but provided noguidance on the scoring sheets regarding how they should interpret the notion'disclosure quality." Subsequent to the analysts' scoring ofthe MD&A, it becameiripoitunt for the purposes of the study to confirm whether the disclosure quality3CKres actjaily riieasured the usefulness of MD&A to them as analysts. As a result,ive i;ondiicted loilow-up interviews and sent questionnaire surveys to the scodngfifiiilysts. The intei'views and the results of the survey (discussed in Section 3)::uggesi that, while not perfect, there is a relatively strong correspondence betweenthe disclosure scores and usefulness.

2, Ses the OSC's 1995 Financial Statement and MD&A Review Program FinalReport and its predecessor reports, including the January 1993 MD&A Guide.

?,. The OSC's annual review programs and ensuing reports are summary assessmentsof conitnon deficiencies In MD&A and do not mention individual firms.

4, iVe a^ked analysts for 16 TSE sectors to score MD&A disclosure quality. How-ever, analysts in six sectors (oil and gas, industrial products/steel, paper and forestproducts, financial services, reai estate & construction, and communications andrneiUti) only scored Ae 1992 MD&A, arguing that the similarity of MD&Adisclosure across the (wo years made it unnecessary to score both years. Thus, weiiii^c jcores fo- 91 firms in 1992. but only 55 firms with scores for both years..-'.nislysts for riic industrial products/other and pipelines sectors ultimately provided:.;orss for fewer than five firms because of time constraints.

:l. B-.;r:a;,i3C; of 'die OCA's commeri!. \n its January 1993 MD&A Guide that there was'.:<.• :iaiix doiincB-tion of .MD&.4., vs also asksd aaalysts to provide scores of MD&A.;•,̂ ci:isur•s quality for MD&A mru'idaied ciiscicsures found more broadly in the,;.:ii;rc annu;,i report. Resalis based on tiiese locaiion-relaxed scores are qualita-;>,:•.;•>• the st:iTid as these ijascd on rhe pjiffiary VfD&A scores.

-V ; i ij." tiTLempt 'cc ivrLlichite cur scorss. we obtained the fiscal 1992 rankings in the'•'Inv-ciai Post Av,'£i-ds Contest i'or ou»' sample firms. The contest assessment is.•.;;;!« s'.;;rv year by a pand ci' anaiysis and representatives of the accountingr[;.::'e.--;iGi:!, ;sir;ci: iho ccrstcs? i-elate>, so averail annual report disclosure and not just'>iD«';.:\, (nc contest rank'ngs confiiitutc onlv partial validation evidence. The rank-


order correlation of 0.349 with our location-relaxed scores is significant at the 1percent level. In addition, the correlation between the MD&A disclosure qualityscores and the number of distinct press releases issued by the firm is 0.292,significant at the 5 percent level.

7. While under the null hypothesis, a benchmark score of zero may seem extreme,analysts were not reluctant to use low scores for each subcomponent (see panel Bof Table 1). A less extreme null would be that MD&A does not exceed the mid-point (i.e., 30 out of 60), denoting moderate quality. Using this null h3fpothesis, theaverage analyst scores for both 1991 and 1992 are also statistically different fromthe null at the 1 percent level.

8. Following the logic underlying note 7, a less extreme null would be the midpointof the survey scale (e.g., 3 out of 6, denoting moderate correspondence). For allstatistical tests performed on our survey results, the mean scores reliably exceedthe midpoint at the 1 percent level.

9. The apparent low response rate (53 out of 416 or 12.7 percent) is due to twofactors. First, the surveys were sent to an unknown mix of buy-side and sell-sideanalysts. The TSFA informed us that buy-side analysts tend not to work withMD&A as much as sell-side analysts and hence, were less likely to respond to thesurvey. Second, 12.7 percent represents a first-request response rate. The TSFAadministered the survey on our behalf and it was not practical for them to send outadditional requests.

10. The analysis refines the content analysis undertaken by Clarkson et al. 1994, whodemonstrate that directional earnings forecasts in annual reports are seldompreempted by prior directional forecasts appearing in the press. To minimize thepossibility of evaluation bias by the researchers, our content analysis was con-ducted ifl a two-step fashion. Initially, a research assistant who was unaware of ouroverall research question read the content of all text and made the assignments.Subsequently, the work was checked by the authors. The results do not changewhen we use the 55 firms that constitute our primary sample.

11. The post-entry disclosure model of Hayes and Lundholm 1996 implies a negativeassociation between the informativeness of segment disclosure and past abnormalprofits as measured by return on equity (ROE). A higher level of aggregation andhence less disclosure serves to conceal the segment to which past abnormal profitsare attributable. If the theoretical predictions of Hayes and Lundholm extendbeyond segment reporting, we would expect to observe a negative associationbetween past ROE and MD&A disclosure quality.

12. We also considered a random walk with drift model based on five years of histori-cal earnings, a market-based approach based on cumulative residuals from themarket model over the twelve months subsequent to the annual report date, and anapproach based on consensus analyst forecast data to classify firms as good news.Further, we considered the following continuous measures: change in earnings(£,̂ 1 - E,) deflated by total assets, cumulative residuals, and analyst forecast error(£,̂ .1 - AF) deflated by total assets. The results are not sensitive to the choice ofmeasure. Additional details can be foimd in Clarkson et al. 1994.

13. Additional measures considered are the total debt plus equity raised by the firmduring fiscal period f + 1, and the amount of equity financing as well as total debtplus equity financing raised over the two years subsequent to the annual reportdate. We also considered two deflators, total assets, and shareholders' equity.Results for the empirical analyses are qualitatively the same based on all measuresof FIN.

Evidence that MD&A is a Part of a Finn's Overall Disclosure Package 133

14. Press releases were excluded because we seek a measure that is free to vary fromour second dependent variable, die number of press releases. To rule out eventsthat qualified as major because a firm only had very few news articles, we furtherreqiiiii-ed that the total number of news articles be no less than 20. While ME can befaulted for not giving more weight to firms experiencing more than one majorevent, ooly 5 out of the 18 firms with major events had multiple events and no firmhad more thaa 2 major events.

15. Following concerns raised by Lang and Lundhoim 1993, we reran the empiricalmodels tests using raw scores and also used rank regressions. Our results usingtbese alternatives are qualitatively the same as those based on industry-adjustedraw scores.

16. The presence of only two firms in sector 6.0 (industrial products/other) causedsome conGem for the industry-adjusted analysis. As a result, we approached thissector from three perspectives. First, we treated sector 6.0 as a separate sector.Second, we deleted sector 6.0 and based the analysis on the remaining 53 firms.Third, we combined the firms in sectors 6.0, 6.5, and 6.7 into a single industrialprodacts sector. Resolts are unaffected by the approach adopted. The resultsreported in the paper are based on the first treatment.

17. We also estimated the MD&A and DPR models simultaneously. The results arequsslitatively unaffected.

18. We also performed the subcomponent analysis in the levels, using a modifiedversion of equation (1). The results are qualitatively similar to analyses using theckmges in subcomponent scores.

ReferencesBarroa, O., C. Kile, and T. O'Keefe. 1999. MD&A quality as measured by the SEC and

aiKiIysts' earnings forecasts. Contemporary Accounting Research 16 (Spring):75-109.

Botosaa, C. 1997. Disclosure level and the cost of equity capital. Accounting Review(My): 323-49.

Bryan, S. 1997. Incremental information content of required disclosures contained inmaiiagement discussion and analysis. Accounting Review (April): 285-302.

Clarkson, P., J. L. Kao, and G. Richardson. 1994. The voluntary inclusion of forecastsin itbe MD&A. section of annual reports. Contemporary Accounting Research(Fall): 423-50.

Firth, M. 1979. The impact of size, stock market listing, and auditors on voluntarydisclosure in corporate annual reports. Accounting and Business Research (Au-turnn): 273-80.

Gibbins, M., A. Richardson, and J. Waterhouse. 1990. The management of corporatefinaEcia! disclosure: Opportunism, ritualism, policies, and processes. Joumal ofAccounting Research (Spring): 121-43.

Hayes, R., and R. Lundhoim. 1996. Segment reporting to the capital market in thepresence of a competitor. Journal of Accounting Research. (Autumn): 261-80.

Healy, P., K. Palepu, and A. Sweeney 1994. Causes and consequences of changes indisclosure strategy. Working paper, MTT and Harvard Business School.

Kile, C 1996. An analysis of the nature and effects of SEC review: Evidence from theSEC's MD&A project. Working paper, Emory University.

Lang, M. and R. Lundholm. 1993. Cross-sectional determinants of analyst ratings ofcr-nnrat'* di -\c nri* loun I of Ar'-'j it'12 P''<i''-'rrh (A"tnmn)-''^ft-7\


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