A New Measure of Disclosure Quality

• In Event: New Measures of Voluntary Disclosure

Abstract

We construct a new measure of disclosure quality based on the level of disaggregation of financial data in firms’ annual reports. Disaggregation of financial statement data is an important aspect of firms’ disclosure behavior, as research has shown that disaggregation helps investors in valuing firms and monitoring managers. Our measure of disclosure quality is unique in that it captures the extent of details in firms’ annual reports, whereas existing disclosure measures capture either forecasts of future earnings, or researcher/analyst ratings of firms’ disclosure quality based on a selected list of line items, or the narrative quality of MD&A. In addition, our measure can be generated for the universe of Compustat non-financial/utility firms and as such can be more easily used to either replicate and retest existing hypotheses or test new hypotheses on a much wider set of firms in the economy. Based on Compustat data from 1963-2009, we conduct three groups of validation tests by examining the association between our disclosure score and analyst forecast dispersion and accuracy, cost of capital, and earnings-returns relations. We find our disclosure score to be negatively (positively) associated with analyst forecast dispersion (accuracy) and negatively associated with cost of capital. In addition, we find that firms with higher disclosure scores exhibit stronger future earnings-returns relation. These results are consistent with our measure capturing disclosure quality.

Authors

• Shuping Chen, The University of Texas at Austin

• Bin Miao, National University of Singapore

• Terry J Shevlin, University of California, Irvine