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Capital Markets

10Ks and Earnings: Longer the Better for Companies

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October 02, 2018

Study shows that as 10-Ks have grown longer investor attention spans have grown shorter

Monday Market Updraft10-Ks and earnings reports are getting longer and longer and it's helping corporate share prices because the bad news is getting buried, according to a study. That’s because company information has become easier and cheaper to produce while investors seemed to have become bored by, or less interested in, the nitty gritty, according to the study from the National Bureau of Economic Research. 

“Information production and dissemination have seen a drastic drop in cost over the past three decades,” write Lauren Cohen and Christopher Malloy of Harvard and Quoc Nguyen of University of Illinois Chicago in their report, “Lazy Pricing.” “With this drop in cost, there has been a paired rise in the amount of information being produced, making the search and processing problem more complex.”

And if investors haven’t kept up with the “increasing magnitude and complexity of these changes,” they miss out on their stock portfolios. That magnitude is large: since 1995, the length of the average 10-K has grown 6 times as long with 12 times more text, the study finds. Still, investors do figure out what’s in the reports and act accordingly, baking the info into the stock price. “[But] this happens with a lag: investors only gradually realize the implications of the news hinted at by document changes, but this news eventually does get impounded into future stock prices and future firm operations.”

This, the authors say, is “consistent with investors simply failing to account for — or be attentive — to the systematic and rich information contained in simple changes to a firm’s annual reports.” Companies that do make changes to their reports “exhibit little to no reaction at the time of public filing … even though there is a robust and systematic relationship (whereby changes predict future negative returns and negative real operational realizations) — with the information only being impounded into price in the future.”

How much are they missing? The authors note that a portfolio that goes long companies that don’t change their reports and shorts those that change, earns 34-58 basis points per month or up to 7% per year in value-weighted “abnormal returns” vs. the previous year.

“These returns continue to accrue out to 18 months, and do not reverse, implying that far from overreaction, these changes imply true, fundamental information for firms that only gets gradually incorporated into asset prices in the months after the reporting change,” the authors write.

The message from all this is that contrary to conventional wisdom, which states that material information is being hidden in 10-Ks, investors are missing, and continue to miss even today, critical information.

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