Understanding the Influences of Financial Reporting, Corporate Disclosures and Financial Media on the Corporate Financial Information Environment

The UK financial sector is a major driver of economic activity and transparent and effective financial communication is a key determinant of its success. Audited financial statements, unaudited corporate disclosures, and information signalled through corporate financial choices are the primary ways that firms communicate with capital market participants. These mechanisms, together with information from analysts, financial journalists, rating agencies and other market commentators external to the firm combine to form the Corporate Financial Information Environment (CFIE).

Narrative disclosures represent a large part of firms' overall financial communications with investors. Textual commentaries help to clarify issues obscured by complex accounting methods and footnote disclosures. In addition, narratives summarise corporate strategy, contextualize results, explain governance arrangements, describe corporate social responsibility policy, and provide forward looking information for investors.

We will study the causes and consequences of corporate disclosure and financial reporting outcomes. The determinants of financial reporting quality and the factors that influence the quality of information disclosed to investors beyond the financial statements are the main focal points of the proposed project.

While a considerable body of research exists on financial narratives, it has been limited by the methods used for measuring the characteristics of such disclosures. In particular, the need to hand-collect relevant data from firms' annual reports and the subjectivity of textual scoring methods have restricted progress. Recent advances in computing and linguistics provide a basis for undertaking more sophisticated analyses. This project brings together a multidisciplinary team with the aim of developing statistical and computer-based techniques for measuring the properties of UK corporate disclosures. In particular, we will develop new ways of measuring the quality and tone of company narratives using computer-based rankings of annual reports. Both the rankings and linguistic techniques on which these rankings are based will be made available to those seeking information on corporate disclosure policy or wishing to undertake their own analysis of specific narrative statements. We will also use the findings from our analysis as the basis for studying how managers communicate expectations of firm performance to investors and they seek to manipulate investors' impressions of reported results.

The project will also study how the CFIE is shaped by the actions of the financial media. Despite voluminous amounts of press commentary and published investment advice, the informativeness of financial media outputs and their impact on management behaviour have not been studied systematically. We aim to develop methods for measuring the content and informativeness of press commentaries, and then use these measures to examine how the financial media interacts with corporate reporting to determine the quality of the CFIE.

The majority of our analysis will be based on large samples of UK firms listed on the London Stock Exchange. We will use complex statistical modelling procedures to explore relations between key variables and to test our predictions. Our statistical tests will be supported by interviews with key stakeholder groups to help us better understand current financial communication issues and practices. Insights from these interviews will be used to refine our research questions and interpret our results.

The project is expected to yield important insights for business policy makers, accounting standard setting bodies and financial market information regulators. We also expect equity market participants including investors, investment analysts, finance directors, auditors, and firm officials to benefit from the research.

As the main role of the CFIE is to ensure capital is efficiently allocated in the economy, the entire economy potentially benefits from research in this area.

Specific beneficiaries include finance directors, auditors and other firm officials responsible for corporate financial reporting and communication, investors in corporate securities and their advisors, financial regulators (The Financial Services Authority, the Dept BIS), and accounting policy makers (e.g., FRC, ASB,EFRAG and the International Accounting Standards Board).

For corporate users, the research will provide insights into the efficacy of alternative accounting and disclosure choices for firms' financial communications. How firms manage their reporting reputation through disclosure policy and accounting choices, and the extent to which reporting reputation affects the cost of capital and/or liquidity will be of particular interest to this group.

The project will also benefit users of corporate financial information. It will provide new evidence on the quality and reliability of firms' disclosure and accounting choices, and the factors that cause the quality of these two dimensions to vary across firms and over time. We will provide systematic evidence on how to read corporate disclosures, and how to identify disclosures that are more or less likely to be informative. Users will also have access to our online tools for the textual analysis of annual reports, other firm disclosures such as interim management statements, and financial media reports.

For accounting and finance regulators, we hope to show how a regulatory approach that co-ordinates policy across disclosure regulation and accounting standards can lead to superior outcomes than regulating these issues separately. We will aim to contribute to early policy thinking about the creation of a UK financial reporting laboratory (FRC 2011), and to two current projects of EFRAG (see enclosed letter of support).

Our dissemination plan includes a wide range of communication and engagement activities designed to inform academic and professional communities, the financial media, and policy makers. We will adopt a portfolio approach to promote user engagement and maximise research impact, including professionally-oriented publications, media coverage, seminars, presentations, and a project-specific website. We will target the research papers of the project at leading international journals, building on the team's strong track record of international peer reviewed publications.

We will organise two conferences to present the project work, and we will contribute to other events managed by the ICAEW. In 2012 the PI will give the P. D. Leake Lecture that will draw on themes developed in the project. A London conference, to be held at the ICAEW, will target academics, professionals and policy makers, and serve as a platform for communicating the project's objectives and discussing issues related to our research agenda. The Manchester capstone conference will present outputs to a similar audience.

The project will be part sponsored by the ICAEW, whom we will work with to ensure the work is widely distributed. We will produce an ICAEW research 'Briefing' that explains the implications of the research in a form that is accessible to accounting and finance professionals. We will also produce articles for a variety of well known user publications and financial media such as Accountancy, the Investors Chronicle, the Financial Times and the Economist. The academic partners' press offices and the ICAEW's media relations team have extensive experience of dissemination activities to non-academic audiences and we will utilise their experience and skills throughout the course of the project.