Public Debt Issuance Impact on Management Forecasting Frequency: Evidence from Regulation Fair Disclosure

• Author: Boyoung Kim,Kyoungwon Mo
• DOI: http://doi.org/10.1111/ajfs.12151
• Published date: 01 October 2016
• Date: 01 October 2016

Public Debt Issuance Impact on

Management Forecasting Frequency:

Evidence from Regulation Fair Disclosure

Kyoungwon Mo

College of Business Administration, Myongji University

Boyoung Kim*

School of Business, Sungkyunkwan University

Received 7 November 2014; Accepted 3 September 2016

Abstract

We examine firms’ strategic management disclosure policies on debt offerings and their con-

sequences on the cost of debt, considering Regulation Fair Disclosure (FD). We find that

firms issue more management disclosures before debt offerings and witness pronounced

increases in management forecasting after Regulation FD, suggesting that Regulation FD

affects their disclosure policy before debt offerings. Furthermore, firms with high information

asymmetry release more management disclosures before debt offerings, and creditors reward

increased public disclosures with a lower cost of debt. We believe that this study contributes

to the literature on debt offerings and the impact of Regulation FD.

Keywords Cost of debt; Debt offering; Management forecasts; Regulation FD; Voluntary dis-

closure

JEL Classification: M40, M41

1. Introduction

Extant literature shows that firms increase disclosure before equity offerings to reduce

information asymmetry, and that this effort is rewarded by a lower cost of equity

offerings (Ruland et al., 1990; Marquardt and Wiedman, 1998; Lang and Lundholm,

2000). However, there is little evidence on whether firms also increase disclosure

before debt offerings to reduce information asymmetry and how creditors evaluate

increases in management earnings forecasts. Consequently, this paper investigates

firms’ strategic disclosure policies before debt offerings and their consequences on

the cost of debt, considering the impact of Regulation Fair Disclosure (FD).

*Corresponding author: Boyoung Kim, School of Business, Sungkyunkwan University, 25-2,

Sungkyunkwan–ro, Jongno-gu, Seoul, Korea, Tel: +82-2-760-0439, Fax: +82-2-760-1350,

email:bykim0405@gmail.com.

Asia-Pacific Journal of Financial Studies (2016) 45, 755–778 doi:10.1111/ajfs.12151

©2016 Korean Securities Association 755

The literature shows that voluntary disclosure of management forecasts prior to

debt offerings allows a firm to lower its cost of debt by decreasing the information

asymmetry between debt issuers and potential investors. For example, Sengupta

(1998) finds that firms with better disclosure policies have a lower effective public

debt interest cost, and Mazumdar and Sengupta (2005) report similar evidence con-

cerning firms offering private debt. These findings imply that managers have a n

incentive to increase management disclosure prior to debt offerings. Frankel et al.

(1995) examine such incentives for external financing through debt and equity

offerings, and find that firms using external financing at least once during the sam-

ple period tend to issue more forecasts than those that do not. However, they find

no evidence that firms financed externally at least once during the sample period

significantly increase management disclosures prior to external financing more than

otherwise.

1

The lack of evidence about the strategic use of management disclosures before

debt offerings may be due to firms’ use of private communication channels with

potential debt lenders, most of whom are financial intermediaries such as banks

and insurance companies (Bartov et al., 2000; Ayers and Freeman, 2003; Collins

et al., 2003). However, the information environment has substantially changed since

Regulation FD was introduced on 23 October 2000 by the Securities and Exchange

Commission (SEC). Regulation FD requires United States public firms to refrain

from disseminating private information selectively to a few privileged parties, such

as equity analysts and financial institutions (SEC, 2000).

2

Consequently, firms have

dramatically increased the quality and quantity of their public information to

reduce information asymmetry and their cost of equity capital (Heflin et al., 2003;

Eleswarapu et al., 2004).

We conjecture that Regulation FD also affects the disclosure policies of debt-

offering firms by shifting their focus from private to public communication

1

Frankel et al. (1995) explain that forces such as legal liability may deter increased manage-

ment disclosures prior to external financing.

2

Rule 100(b) (2) of Regulation FD provides an exemption to four categories of persons or

situations: (i) any person who owes the issuer a duty of trust or confidence; (ii) any person

who expressly agrees to maintain the information in confidence; (iii) an entity whose primary

business is the issuance of credit ratings; and (iv) communications made in connection with

most offerings of securities registered under the Securities Act (Final Rule: Selective Disclo-

sure and Insider Trading, Securities and Exchange Commission, http://www.sec.gov/rules/fi-

nal/33-7881.htm). Therefore, disclosure to specific lenders can be exempt from Regulation

FD if the lenders abide by the confidentiality agreement. If the lenders can still get private

information, firms may not have incentives to increase voluntary disclosures prior to debt

offerings after Regulation FD. In this paper, we assume that the exemptions are not prevalent

in public debt offerings and show that firms issue more management disclosures before debt

offerings prior to debt offerings after Regulation FD, confirming our assumption. Neverthe-

less, we recommend readers interpret our findings with careful consideration of the exemp-

tions of Regulation FD.

K. Mo and B. Kim

756 ©2016 Korean Securities Association