The Relationship between Voluntary Disclosure, External Financing and Financial Status

• Author: Håkan Jankensgård
• Published date: 01 September 2015
• DOI: http://doi.org/10.1111/jbfa.12120
• Date: 01 September 2015

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 42(7) & (8), 860–884, September/October 2015, 0306-686X

doi: 10.1111/jbfa.12120

The Relationship between Voluntary

Disclosure, External Financing

and Financial Status

H˚

AKAN JANKENSG ˚

ARD∗

Abstract: Using unique Swedish disclosure data from 2007 to 2012, this paper reports three

important sets of findings with regard to the relationship between firms’ voluntary disclosure,

external financing and financial status. First, financially strong firms disclose more than weaker

ones. Second, firms that obtain new financing (equity or debt) disclose more than firms that

do not. Third, the association between voluntary disclosure and financing events is stronger in

financially weak firms. This last finding is new in the literature. Perhaps financially weak firms

that obtain external funding have higher disclosure to counteract contracting and valuation

problems in the financial markets.

Keywords: voluntary disclosure, financial status, external financing, equity issuance, debt

overhang

1. INTRODUCTION

In the capital-markets-transactions hypothesis of voluntary disclosure, firms use dis-

closures strategically to optimize their financing strategies (Healy and Palepu, 2001).1

Since disclosure entails both costs and benefits, it is reasonable to expect that firms are

more forthcoming with information when the benefits are relatively higher, such as in

periods when firms issue securities and benefit directly from a lower cost of capital.

This hypothesis is supported by a growing body of empirical evidence (Choi, 1973;

Gibbins et al., 1990; Lang and Lundholm, 1993; Frankel et al., 1995; Marquardt and

Wiedman, 1999; Lang and Lundholm, 2000; Brockman et al., 2008).

∗The author is at Department of Business Administration, Lund University. The author thanks Hans

Borneroth and Martin Isemo of Kanton for supplying the data and sharing their expertise on the subject

matter. The author thanks an anonymous referee, Niclas Andr´

en, Clas Wihlborg, Jens Forssbaeck, Anders

Vilhelmsson, Fredrik N.G. Andersson, seminar participants at the Knut Wicksell Centre for Financial

Studies, Lund University, and seminar participants at the Lund Accounting Research Seminar, Lund

University, for several valuable comments. The author also gratefully acknowledges the financial support of

the Jan Wallander and TomHedelius foundation. (Paper received September 2014, revised version accepted

April 2015).

Address for correspondence: H˚

akan Jankensg˚

ard, Department of Business Administration, Lund University,

P.O.Box 7080, 220 07 Lund, Sweden. Telephone: +46 46 222 4285.

e-mail: hakan.jankensgard@fek.lu.se

1 Goto et al. (2009) define strategic disclosure as firms’ discretion to disclose or withhold information.

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VOLUNTARY DISCLOSURE AND EXTERNAL FINANCING 861

In this paper, I add to the literature on voluntary disclosure and financing

events by examining whether this relationship is conditioned by a firm’s financial

status. Specifically, I develop and test the hypothesis that the association between

disclosure and external financing is more pronounced in financially weaker firms.

Corporate finance theory suggests that contracting problems in the financial markets

get increasingly severe as the firm’s financial status declines (consider,for example, the

debt-overhang problem in Myers, 1977). To the extent increased disclosure is helpful

in overcoming such contracting problems, we expect a firm’s efforts at disclosure in

relation to equity offerings to be a decreasing function of the firm’s financial status.

Furthermore, since disclosure reduces information asymmetries, it also decreases the

adverse-selection component of the cost of capital (Beyer et al., 2010), which may

be particularly large in weak firms that issue securities because of higher asset-value

uncertainty.2Finally, the demand for disclosure may be higher when financially weak

firms issue securities. A firm’s equity will, given limited liability, increasingly tend to

be priced as an option as the firm gets financially weaker (Myers, 1977). This option

characteristic suggests that precise volatility estimates become comparatively more

important in the valuation of weak firms, increasing the demand for disclosure.

The example of Scandinavian Airlines (SAS) serves to illustrate the potential

importance of considering financial status in connection with disclosure and financing

events. In 2010, SAS became the first company ever to achieve the maximum score in

a yearly ranking concerning the level of disclosure in annual reports by Swedish-listed

firms. No company has since repeated this achievement. Such rankings of financial

reports are sometimes referred to as “beauty contests”, and, according to this logic, SAS

would have been the ultimate beauty. Some observers may have dissented, however.

During 2009 and 2010, SAS struggled with deteriorating operating performance and

experienced serious financial difficulties. Operating losses were severely weakening

the company’s liquidity,and bankruptcy was fast becoming a realistic prospect. In both

these years, SAS issued new shares to recapitalize the company and shore up its debt-

laden balance sheet and it issued two public bonds in 2011. By 2012, when SAS issued

no securities, its score in the disclosure rankings had fallen by over 20%.

In analyzing the relationship between disclosure, external financing and financial

status, this study benefits from a unique database on disclosure scores for Swedish-

listed firms between 2007 and 2012. The database comprises rankings of annual

reports, quarterly reports and web-based disclosure. For each of these disclosure

channels, firms receive points to the extent that they publish items that are perceived

to be useful to analysts and minority shareholders. Since 2007, the ranking has

been performed by Kanton, a Swedish financial advisory firm, in collaboration with

Aktiespararna, an association representing the interests of minority shareholders in

Sweden. These data (henceforth referred to as the KA-scores) are unique in the

sense that actual disclosure items targeting voluntary disclosure have been consistently

coded for a broad sample of firms over a period of 6 years (and running). In

short, the KA-scores offer a rare chance to explore voluntary disclosure with recent

2 For example, asset-value uncertainty would be higher in these firms to the extent that their survival

and future performance depend on key changes, such as replacing the management team or altering the

business model.

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