Feb. 28, 2020

Disclosure of sensitive information swayed by outside directors

Study looks at how companies solve dilemma of optimal disclosure to investors
Research looks at how outside directors help a company arrive at the right balance for disclosures.
Research looks at how outside directors help a company arrive at the right balance for disclosures.

Companies must walk an uneasy tightrope when releasing sensitive information to investors. Too much could tip off a competitor about your plans, giving them the advantage they need to steal your thunder. Too little could result in your being labelled opaque in terms of financial reporting, driving away the investors you need to grow your company.

A new study examines how firms solve this dilemma of optimal level of disclosure. It found that during this sensitive stage in the life of a business, the type of people chosen to be the outside directors of a company’s board can make a crucial difference in what, and how much, information it makes public.

Outside directors are not shareholders or employees in the company. They instead receive an annual retainer fee to monitor and advise corporate leaders while protecting investors’ interests.

“We found it is very important to look at the professional background of such directors so that their characteristics are consistent with the firm’s targeted disclosure policy,” says study co-author Dr. Luminita Enache, PhD, who is an assistant professor of accounting at the Haskayne School of Business.

Luminita Enache

Haskayne researchers Luminita Enache, above, and colleagues studied about 100 biotech companies.

Adrian Shellard, for the Haskayne School of Business

Study includes Great Recession

The other co-authors included Dr. Anup Srivastava, PhD, an associate professor at Haskayne who is a Canada Research Chair in Accounting – Decision-Making and Capital Markets; and Dr. Antonio Parbonetti, PhD, who is a professor at the University of Padua in Italy.

The study, which was recently published in the Review of Quantitative Finance and Accounting, examined about 100 biotech companies involved in developing things such as new drugs to treat illnesses.

“We looked at what we call proprietary information, which was hand collected from companies’ annual reports,” says Enache. “It includes details about the drug molecule, the stage of drug development, and the companies’ near-term plans to launch a new product.”

If you disclose too much of that information, competitors can fine-tune their own product development and market plans to your company’s disadvantage, she says. On the other hand, outside investors demand such information to make timely buy or sell decisions, she says.

Data was gathered on firms traded on the New York and Nasdaq stock exchanges from 2005 to 2016. It includes the time when companies faced the financial crisis — or so-called Great Recession — of 2007 to 2008, which was the most significant economic downturn since the Great Depression.

“The biotech sector is important to our study because these are young companies and don’t have a lot of revenue, but require billions of dollars of investment to develop the next blockbuster drug, which takes years in making,” says Enache. “Their only viable option to meet shortfalls in funding is to get investors to believe in their projects by providing information about the prospects of their research.”

Directors play vital role

The study found that companies with outside board directors who were “support specialists” were more cautious about proprietary disclosures, she says. Such people consisted of experts such as bankers, lawyers or consultants who were often managers in their own separate firms, she says.

But companies with outside directors who were “community influentials” were found to be more forthcoming about disclosures, says Enache. As people ranging from politicians and clergy to academicians and leaders of community organizations, they provided boards with non-business perspectives, she says, adding they also seem less knowledgeable about the downsides of providing too much information.

Boards of directors play an important role in the economy, as demonstrated by the corporate frauds, accounting errors, bad executive compensation packages, and poor investment decisions that helped bring on the Great Recession, she says.

“The outside directors monitor and control the CEO’s actions, acting on behalf of the shareholders, but they also play a dual role as advisers and as a sounding board to the CEO for big ideas,” says Enache. “We provide a new perspective on how outside directors help the company and its investors in arriving at the right balance between too little and too much disclosure of sensitive information.”