Selective disclosure and the role of Form 8‐K in the post‐Reg FD era

• Author: Zhejia Ling,Rong Zhao,Cristi Gleason
• DOI: http://doi.org/10.1111/jbfa.12416
• Date: 01 March 2020
• Published date: 01 March 2020

DOI: 10.1111/jbfa.12416

Selective disclosure and the role of Form 8-K in the

post-Reg FD era

Cristi Gleason1Zhejia Ling2Rong Zhao3

1Tippie College of Business, University of Iowa,

Iowa City, USA

2Debbie and Jerry Ivy College of Business, Iowa

State University, Ames, USA

3HaskayneSchool of Business, University of

Calgary, Calgary, Canada

Correspondence

CristiGleason, Tippie College of Business, Univer-

sityof Iowa, 21 E Market St, Iowa City, IA 52242,

USA.

Email:cristi-gleason@uiowa.edu

Abstract

We investigate the impact of Form 8-K filings on cross-firm dif-

ferences in analysts’ private or idiosyncratic information in the

post-Reg FD era. Using firms’ connections to the investment

community to identify the likelihood of selective disclosure, we doc-

ument differences in analysts’ idiosyncratic information arising from

selective disclosure before 8-K filings. While filings of 8-Ks pursuant

to Reg FD attenuate the link between connections and analysts’

idiosyncratic information, they do so only after selective disclosures

have already resulted in some analysts having better private infor-

mation. In addition, the connections continue to facilitate private

information search after the filings of non-Reg FD-specific 8-Ks.

KEYWORDS

analysts’ idiosyncratic information, connections, Form 8-K filing,

selective disclosure

JEL CLASSIFICATION

G14, M41

1INTRODUCTION

The Securities and Exchange Commission (SEC) issued Regulation Fair Disclosure (Reg FD) to address its growing

concern that a “privileged few gain an informational edge” and “profit or avoid a loss at the expense of those kept

in the dark.” Despite the intent of Reg FD, recent research finds evidence consistent with some analysts continuing

to receive selective disclosures from private interactions with corporate management (e.g., Brown, Call, Clement,

& Sharp, 2015; Green, Jame, Markov, & Subasi, 2014a) and with market participants pricing the risk of selective

disclosure (Cai, Walkling, & Yang,2016).1Perhaps because of the difficulty in preventing selective disclosure, rather

than forbidding selective disclosure, Reg FD requires firms to promptly file an 8-K to broadly disseminate information

selectively disclosed to securities market professionals. Subsequently, SEC Rule 33-8400 expanded the number

of events for which firms are required to file an 8-K and accelerated the filings deadlines, potentially improving

1As used in this study,“selective disclosure” refers to private communication between corporate management and one or more segments of the investment

communitywithout regard to whether the information communicated is material or immaterial.

J Bus Fin Acc. 2020;47:365–396. wileyonlinelibrary.com/journal/jbfa c

2019 John Wiley & Sons Ltd 365

366 GLEASON ET AL.

the timeliness of public disclosure. We examine whether 8-K filings reduce the impact of selective disclosure post

Reg FD.

We focus on Form 8-K because of its intended role to providebetter and faster disclosure of material information.

The SEC requires registrant firms to file Form 8-K to timely disclose material corporate events such as entry into a

significant contractor new product development. More importantly, firms that selectively disclose material non-public

information to securities marketprofessionals or security holders at occasions such as analyst days or investor confer-

ences are required to make that information public within 24 hours, a requirement that can be met by filing Form8-K

(or by other methods that effect broad and non-exclusionarydistribution of that information).

However,private communication between corporate management and the investment community may still occur

without triggering 8-K filings. Corporate management is not prohibited from “disclosinga non-material piece of infor-

mation to an analyst, evenif, unbeknownst to the issuer, that piece helps the analyst complete a ‘mosaic’ of information

that, taken together,is material.”2Firms may also be strategic in filing 8-Ks. Management can time the filings of many

8-Ks within the confines of the regulations and bundle certain news items to avoidor minimize negative reactions from

the capital markets (Goldstein & Wu, 2015; Segal & Segal, 2016; Tian, 2015). Strategic filing of 8-Ks to “paper things

up” (Brown et al., 2015) along with the “mosaic” exceptioncast doubt on the effectiveness of 8-K filings in leveling the

playing field.

A challenge for researchers is the difficulty in identifying selective disclosure and anyinformation advantage arising

from it. We rely on the theoretical model in Barron, Kim, Lim, and Stevens (1998, hereafter BKLS) and the empirical

implementation in prior studies (e.g., Barron, Byard, & Kim, 2002; Barron, Byard, & Yu, 2008; Mohanram & Sunder,

2006) to measure analysts’ private information arising from selective disclosure. BKLS is uniquely suited for our pur-

pose because it allows us to disentangle the common and idiosyncratic components of analysts’ total information.

We draw on recent research that suggests the social network is an important channel of private communications

(e.g., Cai et al., 2016; Cohen, Frazzini,& Malloy, 2008, 2010; Engelberg, Gao, & Parsons, 2012), and use managers’ and

board members’ social connections to the investment community as a measure of cross-firm differences in analysts’

private or idiosyncraticinformation. Using BoardEx data, we measure firms’ connections to the investment community

as the number of unique investment firms to which the CEO, CFO,or board members have education or employment

connections (Connection).3We identify high-, medium-,or low-connection firms using tercile rankings of Connection

standardized every year.We then use a matched sample research design where low-connection firms are matched to

high-connection firms of the closest size to minimize the effect of firm size on analyst information environment.

Using a large set of non-earnings announcement 8-Ks for our matched sample, we find that 8-K filings alter the

relation between connections and both the proportion and precision of analysts’ idiosyncratic information. Analysts

covering highly-connected firms have a higher proportion of idiosyncraticinformation and more precise idiosyncratic

information prior to 8-K filings but not after.In contrast, connections are not associated with the precision of analysts’

common information either before or after 8-K filings, evidence that firms’ connections to the investment community

are not simply a proxy for other firm attributes that indicate better public disclosures. We also find high-connection

firms have relatively higher bid-ask spreads both before and after 8-K filings but they experiencegreater decrease in

spreads, consistent with 8-K filings mitigating investor concerns about informed trading due to selective disclosure

around 8-K filings.

Further analyses reveal that the impact of 8-K filings varies with the type of 8-Ks. Reg FD-specific 8-Ks attenuate

the association between firms’ connections and analysts’ idiosyncratic information. However, connections continue

to facilitate information transfer after the filings of non-Reg FD-specific 8-Ks where the “mosaic” exception plays

a more important role. The differential impact of Reg FD 8-Ks suggests that managerial discretion and the mosaic

exception reduce the effectiveness of 8-K filings in leveling the playing field. In addition, the impact of 8-K filings

2http://www.sec.gov/rules/final/33-7881.htm

3Educational and employment connections is one proxy,but not the only proxy, for the likelihood of selective disclosure. Other examples include political

connections (Christensen,Mikhail, Walther, & Wellman, 2017), brokerage size (Mohanram & Sunder,2006) and investor conferences (Bushee, Jung, & Miller,

2011;Green et al., 2014a, 2014b).

GLEASON ET AL.367

is concentrated in low cyclicality industries where analysts benefit more from firm-specific selective disclosure

compared to high-cyclicality industries.

We conduct additional firm-levelanalyses on the average analyst response to 8-K filings to corroborate the insights

obtained from the BKLS measures. Following prior literature, we find that analysts who cover less connected firms

revise their earnings forecasts sooner after 8-K filings and their forecast revisions are of greater magnitude, compared

to analysts coveringhighly-connected firms, suggesting that on average analysts covering less-connected firms are less

likely to haveselectively learned the information prior to the 8-K (Charoenrook & Lewis, 2009; Kross & Suk, 2012).

Althoughour tests are generally limited to firm-level tests, we conduct within-analyst tests using analysts who cover

both high- and low-connection firms to triangulate our firm-level analysis. Wefind a consistent pattern of quicker revi-

sions following 8-Ks filed for the less-connected firms than for high-connection firms covered bythe same analyst. We

also find a pattern of greater relative forecast accuracyfor high-connection firms prior to 8-K filings but not after 8-Ks

are filed. Togetherthese results imply pre-filing selective disclosure allows some analysts covering highly-connected

firms to have better private information pre-8-K.

Our study makes several important contributions to the literature. Our findings help regulators and researchers

recognize the effectiveness as well as the deficiencies of 8-Ks in leveling the information playing field. Our evidence

suggests that connections play a critical role in analysts’ idiosyncratic information discovery prior to 8-K filings, con-

sistent with investment professionals seeking an information edge through various connections and channels in the

post-Reg FD era (e.g., Green et al., 2014a; Soltes, 2014). While filings of 8-Ks pursuant to Reg FD appear to attenuate

the link between connections and cross-firm differences in analysts’ idiosyncratic information, they do so only after

selective disclosures have already resulted in some analysts having better private information. Thus, the inability of

the SEC to observe private interactions undermines the effectiveness of Reg FD, consistent with Soltes (2018). Our

findings suggest that 8-Ks (or other wide-distribution channels) as the only remedy Reg FD provides are unlikely to

provide a sufficient tool for levelingthe information playing field.

Our study also extends a growing stream of literature examiningthe effect of social networks on the financial mar-

kets (e.g.,Cai et al., 2016; Cohen et al., 2010). Our results reinforce the perceptions of market participants that even in

the post-Reg FD era, private communications between corporate management and the investment community occur

through broad and diversesocial networks (Cai et al., 2016) and beyond highly visible events such as the broker-hosted

conferences.

Some important caveats remain. First, regardless of how studies measure connections (e.g., connections of a cov-

ered firm’s senior officers to the investment community, connections inferred from brokeragehouses’ political con-

tributions, or an individual analyst’s educational ties to the firm she covers), direct evidence in the sense of observing

private conversations between individuals is elusive.4Second, our evidence that 8-Ks remediate differences in the

information advantage held by some analysts covering high-connection firms does not permit us to conclude firms are

violating Reg FD. The information advantage may arise from immaterial disclosures that allow some analysts to piece

together a “mosaic”.In practice, there is considerable uncertainty about what constitutes material information among

both managers and regulators (Soltes, 2018).

2LITERATURE REVIEW

2.1 Social network and analysts’ private information post Reg FD

The practiceof selective disclosure and the related impact on the investment community have evolved since the imple-

mentation of Reg FD. Recent studies show that private interactions with corporate management continue to help

4Soltes’ (2014) approach of obtaining internal communication records at one single firm offers a glimpse of what one can learn from a field study that is not

typicallyfeasible in archival research.