Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature$ Paul M. Healy*, Krishna G. Palepu
Graduate School of Business, Harvard University, Boston, MA 02446, USA Received 14 January 2000; received in revised form 16 March 2001
Abstract Financial reporting and disclosure are potentially important means for management to communicate ﬁrm performance and governance to outside investors. We provide a framework for analyzing managers’ reporting and disclosure decisions in a capital markets setting, and identify key research questions. We then review current empirical research on disclosure regulation, information intermediaries, and the determinants and economic consequences of corporate disclosure. Our survey concludes that current research has generated a number of useful insights. We identify many fundamental questions that remain unanswered, and changes in the economic environment that raise new questions for research. r 2001 Published by Elsevier Science B.V. JEL classiﬁcation: D82; G30; G33; G41; M41 Keywords: Reporting decisions; Voluntary disclosure
$ This paper has beneﬁted from comments from S.P. Kothari and Ross Watts (the editors), as well as participants at the 2000 JAE Conference. We are also grateful to Tatiana Sandino for research assistance, and the Division of Research at the Harvard Business School for ﬁnancial support.
*Corresponding author. Tel.: +1-617-495-1283; fax: +1-617-496-7387. E-mail address: email@example.com (P.M. Healy). 0165-4101/01/$ - see front matter r 2001 Published by Elsevier Science B.V. PII: S 0 1 6 5 - 4 1 0 1 ( 0 1 ) 0 0 0 1 8 - 0
P.M. Healy, K.G. Palepu / Journal of Accounting and Economics 31 (2001) 405–440
1. Introduction Corporate disclosure is critical for the functioning of an eﬃcient capital market.1 Firms provide disclosure through regulated ﬁnancial reports, including the ﬁnancial statements, footnotes, management discussion and analysis, and other regulatory ﬁlings. In addition, some ﬁrms engage in voluntary communication, such as management forecasts, analysts’ presentations and conference calls, press releases, internet sites, and other corporate reports. Finally, there are disclosures about ﬁrms by information intermediaries, such as ﬁnancial analysts, industry experts, and the ﬁnancial press. In this paper we review research on ﬁnancial reporting and voluntary disclosure of information by management, summarize key research ﬁndings, and identify areas for future work. Section 2 examines the forces that give rise to demand for disclosure in a modern capital-market economy, and the institutions that increase the credibility of disclosures. We argue that demand for ﬁnancial reporting and disclosure arises from information asymmetry and agency conﬂicts between managers and outside investors. The credibility of management disclosures is enhanced by regulators, standard setters, auditors and other capital market intermediaries. We use the disclosure framework to identify important questions for research, and review available empirical evidence. Section 3 reviews the ﬁndings on the regulation of ﬁnancial reporting and disclosure. Much of this research documents that earnings, book values, and other required ﬁnancial statement information is ‘‘value relevant’’. However, fundamental questions about the demand for, and eﬀectiveness of, ﬁnancial reporting and disclosure regulation in the economy remain unanswered. Research on eﬀectiveness of auditors and information intermediaries is discussed in Section 4. There is evidence that ﬁnancial analysts generate valuable new information through their earnings forecasts and stock recommendations. However, there are systematic biases in ﬁnancial analysts’ outputs, potentially arising from the conﬂicting incentives that they face. While theory suggests that auditors enhance the credibility of ﬁnancial...