Do Improvements in the Information Environment Enhance Insiders’ Ability to Learn from Outsiders?

• Author: GILBERTO LOUREIRO,ALVARO G. TABOADA
• Date: 01 September 2015
• DOI: http://doi.org/10.1111/1475-679X.12082
• Published date: 01 September 2015

DOI: 10.1111/1475-679X.12082

Journal of Accounting Research

Vol. 53 No. 4 September 2015

Printed in U.S.A.

Do Improvements in the

Information Environment Enhance

Insiders’ Ability to Learn from

Outsiders?

GILBERTO LOUREIRO

∗AND ALVARO G. TABOADA

†

Received 5 June 2014; accepted 23 March 2015

ABSTRACT

We examine whether and how an exogenous shock to the information en-

vironment changes insiders’ ability to learn from outsiders. We document

three main findings. First, we find an increase in investment-to-price sensi-

tivity following the adoption of International Financial Reporting Standards

(IFRS). Second, we show that the relation between the market reaction to

M&A deal announcements and the likelihood of deal completion becomes

stronger after IFRS adoption. Third, we find significant improvements in

post-acquisition operating and stock return performance post-IFRS adoption.

These results are more pronounced for firms that experienced significant in-

creases in foreign institutional ownership around IFRS adoption, especially

when these foreign investors are from countries that matter for the firm’s

growth opportunities. Taken together, our findings suggest that insiders’

∗University of Minho; †University of Tennessee.

Accepted by Philip Berger. Part of this work was developed while Gilberto Loureiro was

visiting Nova School of Business and Economics. We thank an anonymous referee, participants

at the 2012 FMA Annual Meeting, the 2013 FMA European Conference meeting, Lubrafin

2014 meeting, PFN 2014 meeting, and seminar participants at the University of Tennessee,

Cat´

olica Lisbon, and Porto Business School for valuable comments and suggestions. Gilberto

Loureiro thanks Fundac¸˜

ao para a Ciˆ

encia e a Tecnologia (FCT), COMPETE, and QREN for

financial support. This paper was previously circulated under the title “Do Improvements in

the Information Environment Affect Real Investment Decisions?”

863

Copyright C,University of Chicago on behalf of the Accounting Research Center, 2015

864 G.LOUREIRO AND A.G.TABOADA

ability to learn from outsiders improves post-IFRS, and this improved ability

to learn from outsiders leads to real economic gains.

JEL codes: F30; G30; M40

Keywords: Investment-to-price sensitivity; informational feedback effect;

stock price informativeness

1. Introduction

A growing literature highlights the informational feedback effect of

stock prices and suggests that managers can learn from the information

contained in stock prices when making corporate decisions, such as invest-

ment decisions (Chen, Goldstein and Jiang [2007], Foucault and Fresard

[2012]), mergers and acquisitions (Luo [2005]), and takeover activities

(Bond, Edmans, Goldstein, [2012]). This evidence suggests that insiders

can learn from outsiders. We know, however, little about the mechanism

that facilitates learning.

We posit that an exogenous shock to the information environment can

enhance insiders’ ability to learn from outsiders. We use the mandatory

adoption of International Financial Reporting Standards (IFRS) as the in-

formation shock for the following reason.1IFRS enhances comparability

between different markets (i.e., enhances the ability of investors to under-

stand foreign markets better), thereby encouraging investors to hold for-

eign stocks.2That is, post IFRS there are “new” outsiders, namely investors

from foreign markets about which the insider is less familiar. Just like any

other investor, foreign investors react to the public announcements made

by insiders regarding their future investment decisions. The corresponding

stock price reaction allows insiders to learn what the market thinks of their

future investment plan, and, accordingly revise it, discontinue it or follow

through on its implementation. The arrival of new outsiders on the market

post-IFRS allows insiders to glean previously unavailable information. For

this scenario to hold, however, the following conditions have to be fulfilled:

(i) some of the foreign investors should be coming from foreign markets

that potentially affect the growth opportunities of the insider’s firm at least

to some degree, and (ii) the foreign holdings have to be economically sig-

nificant, in order to move stock prices, and accordingly, for managers to

learn from the price.

We examine the above-scenario in two ways. First, we examine

investment-to-price sensitivity changes around the information shock; if

1Several studies use mandatory IFRS adoption as an exogenous shock in information asym-

metry. For example, Naranjo, Saavedra, and Verdi[2014] use mandatory IFRS adoption to ex-

amine how changes in information asymmetry affect firms’ financing decisions. Hail, Tahoun,

and Wang [2014] use IFRS adoption as an exogenous shock to examine changes in dividend

payout.

2See, for example, DeFond et al. [2011], Florou and Pope [2012], Yu and Wahid [2014].

INSIDERS’ABILITY TO LEARN FROM OUTSIDERS 865

insiders’ ability to learn from outsiders improves after the adoption of IFRS,

investment-to-price sensitivity should increase, as managers use the new in-

formation impounded into stock prices by outsiders to help guide their in-

vestment decisions. Second, we examine whether the relation between the

market reaction to M&A announcements and the likelihood of deal com-

pletion changes around IFRS adoption; if insiders are better able to learn

from stock prices post-IFRS, the market reaction to an M&A announcement

should be a better predictor of deal completion post-IFRS.

We test our main hypotheses by employing a difference-in-differences

methodology using a treatment sample of mandatory IFRS adopters and

two separate control groups: (1) firms from countries that did not adopt

IFRS during our sample period, and (2) voluntary IFRS adopters in our

sample of mandatory IFRS adopting countries.3Our final sample consists

of 32,158 firms from 50 countries for the period 1990 through 2012. Our

treatment sample consists of 11,457 mandatory IFRS-adopting firms from

31 countries that adopted IFRS prior to 2011. Our control groups include

19,656 firms from 19 countries that had not adopted IFRS as of 2010 and

1,045 voluntary IFRS adopters from our sample of IFRS-adopting countries.

We document several new findings. Consistent with our predictions, we

find an increase in investment-to-price sensitivity following IFRS adoption

for our treatment firms, relative to the control groups; we document that

the increase in investment-to-price sensitivity is concentrated in firms that

experience significant increases in foreign institutional ownership around

IFRS adoption, especially when foreign investors are from countries that

are important to the firm’s growth opportunities (measured by whether

the firm’s primary industry represents a significant fraction of the total mar-

ket capitalization of the foreign investors’ country). Second, we document

an increase in the ability of the market reaction to M&A deal announce-

ments (measured as the value-weighted average abnormal returns of targets

and acquirers) to predict deal completion post-IFRS, especially for deals in

which outsiders are more likely to have information that is new and rel-

evant to insiders (e.g., deals in which acquirers experienced an increase

in foreign ownership from the target country around IFRS adoption and,

at the same time, the acquirer’s primary industry represents a significant

fraction of the target country’s total market capitalization).

Our findings suggest that insiders’ ability to learn from outsiders

improves post-IFRS adoption. As a final test, we examine whether this

improved ability to learn from outsiders yields real economic gains. We

find significant improvements in post-acquisition operating and stock

price performance post-IFRS, which is stronger in deals in which learning

is more likely to take place. The results are economically significant. We

3In our analysis of M&A deals, we only use a control group of acquirers from non-IFRS-

adopting countries because we have very few acquirers that voluntarily adopt IFRS in our

smaller M&A sample.