Alternative information sources financial statements

ADS

Financial statements have long been regarded as a major source of information for users. However, financial statements increasingly compete with alternative sources of information. One major source of alternative information is analysts’ forecasts and recommendations. Another source is economic, industry, and company-specific news. With continued development of the Internet, information availability for investors will increase. In this section we discuss some of the major alternative information sources: (1) economy, industry, and company news; (2) voluntary disclosures; and (3) information intermediaries (analysts).

Economic, Industry, and Company Information

  Investors use economic and industry information to update company forecasts. Examples of macroeconomic news that affects the entire stock market include data on economic growth, employment, foreign trade, interest rates, and currency exchanges. The effects of economic information vary across industries and companies based on the perceived exposure of an industry’s or a company’s profits and risks to that news. Investors also respond to industry news such as commodity price changes, industry sales data, changes in competitive position, and government regulation. Moreover, company-specific information impacts user behavior examples are news of acquisitions, divestitures, management changes, and auditor changes.

Voluntary Disclosure

 Voluntary disclosure by managers is an increasingly important source of information. One important catalyst for voluntary disclosure is the Safe Harbor Rules. Those rules provide legal protection against genuine mistakes by managers who make voluntary disclosures. There are several motivations for voluntary disclosure. Probably the most important motivation is legal liability. Managers who voluntarily disclose important news,  especially of an adverse nature, have a lower probability of being sued by investors.   Another motivation is that of expectations adjustment. It suggests managers have incentives to disclose information when they believe the market’s expectations are sufficiently   different from their own. Still another motivation is that of signaling, where managers are said to disclose good news to increase their company’s stock price. A more recent motivation advanced for voluntary disclosures is the intent to manage expectations. Specifically, managers are said to manage market expectations of company performance so that they can regularly “beat” market expectations..


Information Intermediaries

 Information intermediaries, or analysts, play an important and unique role in financial reporting. On one hand, they represent a sophisticated and active group of users. On the other hand, they constitute the single most important source of alternative information. As such, standard setters usually respond to analysts’ demands as well as the threat they pose as a competing source of information. Information intermediaries represent an industry involved in collecting, processing, interpreting, and disseminating information about the financial prospects of companies. This industry includes security analysts, investment newsletters, investment advisers, and debt raters. Security analysts constitute the largest segment of information intermediaries, which include both buy-side analysts and sell-side analysts. Buy-side analysts are usually employed by investment companies or pension funds such as TIAA-CREF, Vanguard, or Fidelity. These analysts do their analysis for in-house use. Sell-side analysts provide analysis and recommendations to the public for a fee (for example, Value Line and Standard & Poors) or privately to their clients (for example, analysts at Salomon Smith Barney and Charles Schwab). In short, sell-side analysts’ reports are used by outsiders while buy-side analysts’ reports are used internally. Another large component of information intermediaries includes investment newsletters such as Dow Theory Forecasts and Smart Money. Credit rating agencies such as Moody’s also are information intermediaries whose services are aimed at credit agencies.

Information intermediaries are not directly involved in making investment and credit decisions. Instead, their objective is to provide information useful for those decisions. Their outputs, or products, are forecasts, recommendations, and research reports. Their inputs are financial statements, voluntary disclosures, and economic, industry, and company news. Information intermediaries create value by processing and synthesizing raw and diverse information about a company and output it in a form useful for business decisions. They are viewed as performing one or more of at least four functions:

1. Information gathering. This involves researching and gathering information about companies that is not readily available.
2. Information interpretation. A crucial task of an intermediary is the interpretation of information in an economically meaningful manner.
3.  Prospective analysis. This is the final and most visible task of an information
4. intermediary involving both business analysis and financial statement analysis.  The output includes earnings and cash flow forecasts.
5.  Recommendation. Analysts also often make specific recommendations, such as buy/hold/sell recommendations for stocks and bonds.

By providing timely information that is often of a prospective nature and readily amenable to investment decision making, investment intermediaries perform an important service. Arguably, the growth of information intermediaries has reduced the importance of financial statements to capital markets. Still, information intermediaries depend significantly on financial statements, while at the same time they view financial statements as a competing information source.

ADS