The effect of profitability of foreign sales on the quantity of forward looking disclosures of U.S. multinational firms

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Amsterdam Business School

Master thesis

The effect of profitability of foreign sales on the quantity of forward looking

disclosures of U.S. multinational firms

Name: Mrs. M. Momen-Dehpoor

Student number: 10867937

Thesis supervisor: dr. W. Janssen & dr. S.W. Bissessur

Date: 16 June 2016

Word count: 14427

MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam

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Statement of Originality

This document is written by student Moska Momen-Dehpoor who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

The management discussing and analysis (hereafter: MD&A) section is a significant part of the annual report, that contains managerial commentary about a firm’s recent state and future prospects. The focus of this study is on the quantity of forward looking disclosures in the MD&A. More specifically, I examine the association between foreign profitability and the level of forward looking disclosure in the MD&A. Prior study suggests why managers withhold news. Focusing on segmental information, they show that, managers may want to withhold bad news if this news reveals negative consequences of managers’ investment strategy and actions. Managers usually have more information about the expected profitability of firm’s present and upcoming investments than outsiders. This information asymmetry makes it difficult for outside capital providers to assess the profitability of the firm’s investment opportunities.

This paper focus on the quantity of forward looking disclosures in the MD&A, differs from those of recent studies, which focus on the tone (i.e., optimistic versus pessimistic) of de MD&A disclosures and segment related sales. Prior research shows that there is an information asymmetry problems related to foreign sales, and therefore I expect that firm performance should be particularly sensitive to disclosure decisions related to foreign operations. I predict that profitability of foreign sales is related to the amount of forward looking disclosures, and find results consistent with this prediction.

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1 Introduction

1.1 Background

The management discussing and analysis (hereafter: MD&A) section is a significant part of the annual report, that contains managerial commentary about a firm’s recent state and future prospects (Muslu, Radhakrishan, Subramanyam, & Lim, 2015). The MD&A provides managers with an opportunity to express their forthcoming expectations and strategic plans straight to the public. However, regulators and users have been critical of the quantity and quality of forward looking disclosures in the MD&A (Travcar, 1998; Securities and Exchange Commission (SEC), 2003). The Securities and Exchange Commission (2003) argues that firms do not make adequate forward looking information available in the MD&A and the provision of such information will improve firm’s information environment (Muslu, Radhakrishan, Subramanyam, & Lim, 2015). The focus of this study is on the quantity of forward looking disclosures in the MD&A. More specifically, I examine the association between foreign profitability and the level of forward looking disclosure in the MD&A.

Accounting information plays two important roles in market-based economies (Beyer, Cohen, Lys, & Walther, 2010). It allows capital providers (shareholders and creditors) to estimate the return probable of investment opportunities (the ex-ante or valuation role of accounting information). Moreover, it allows capital providers to monitor the use of their capital once committed (the ex-post or stewardship role of accounting information). Therefore, outsiders have two reasons to demand for accounting information. First, ex-ante, managers usually have more information about the expected profitability of firm’s present and upcoming investments than outsiders. This information asymmetry makes it difficult for outside capital providers to assess the profitability of the firm’s investment opportunities. This problem worsened because insiders (both managers and owner-managers) have incentives to overstate their firm’s expected profitability. However, if capital providers cannot measure firms’ profitability, they will underprice firms with high profitability and over-price with low profitability, possibly leading to market failure (Akerlof, 1970). Second, the ex-post demand for accounting information arises form a separation of ownership and control, which results in capital providers not having full decision-making rights (Beyer, Cohen, Lys, & Walther, 2010, p. 297). To solve the ensuing agency problems, both implicit and explicit contracts often use accounting information such as the use of resources, decision taken, and generated return of investments.

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To the extent that disclosures function as a monitoring mechanism, managers are controlled to act in the best interest of shareholders. When disclosure quality is reduces, the agency cost hypothesis expects that managers can make (suboptimal) self-maximizing decisions. This suboptimal decision decreases operating performance and reduces firm value (Jensen & Meckling, 1976). For instance, Hope and Thomas (2007) show that firms that discontinue disclosure of geographic earnings have lower foreign profit margins even though they have greater foreign sales growth. This outcome supports the argument that nondisclosure reduces monitoring of managerial decisions, allowing managers to inefficiently increase foreign operations, which reduces foreign profitability (Hope & Thomas, 2007, p. 603). Prior study (Berger & Hann, 2007) suggests two main reasons for why managers withhold news. Focusing on segmental information, they show that, first, managers may want to withhold bad news if this news reveals negative consequences of managers’ investment strategy and actions (agency costs). Second, managers may want to withhold good news if others, such as competitors, can use the information to extract profits from the disclosing firm (proprietary costs). Segment reporting is potentially fertile ground for examining the impact of agency conflicts on disclosure decisions (Berger & Hann, 2007). Managers face proprietary costs of segment disclosure if the revelation of a segment that earns high abnormal profits attracts more competition and hence, reduces the segment’s abnormal profits. Furthermore, managers face agency costs of segment disclosures if the revelation of segment that earns low abnormal profits reveals unresolved agency problems.

Failure to disclose earnings at a disaggregated geographic level declines shareholder’s capability to monitor managers’ choices allied to foreign operations. Majority of the prior literature is devoted to and constant with the agency cost hypothesis that suggests that disclosures are withheld as a consequence of conflicts of interest among shareholders and managers (Berger & Hann, 2007, p. 870). Economic theory propose that a commitment by a firm to increased quantity of disclosure should lower the information asymmetry element of the firm´s cost of capital. While the theory is convincing, so far empirical results concerning increased quantity of disclosure to measurable economic benefits have been diverse. One explanation for the mixed results between studies using statistics from firms publicly registered in the United States is that, under existing U.S. reporting standards, the disclosure setting is already rich (Leuz & Verrecchia, 2000).

Li (2008) finds that firms opportunistically hide poor performance by complicating related information, i.e., the annual report “readability” is lower after a firm’s present earnings are negative or positive but less determined. Bagnoli and Watts (2007), suggested that the

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values of the private information the manager discloses depend on the content of the financial reports. In particular, if the reports contain sufficiently good (bad) news, the manager voluntarily discloses small (large) values of her private information. Dutta and Trueman (2002) analyzes a setting in which a firm’s manager can reliably disclose facts, but not their valuation implications. Consequently, he is uncertain as to how those disclosed facts will be interpreted by investors. Introducing such uncertainty affects the manager’s disclosure strategy in two important ways. First, it becomes a function of the market’s prior valuation of the firm since that valuation provides a clue as to how future disclosures are likely to be interpreted by investors. Second, the disclosure strategy is no longer characterized, in general, by a single good news/bad news partition of the manager’s private information. There is little information known about the effect of forward looking disclosers in general and the association with accounting quality.

The objective of this study to add to this developing stream of research by studying to what extent foreign sales is associated to the level of forward looking disclosures for a large sample of MD&A disclosures. Segment reporting is potentially fertile ground for examining the impact of agency conflicts on disclosure decisions (Berger & Hann, 2007). Hope and Thomas (2007) show that geographic disclosure is related to monitoring of managerial decisions and consequently firm profitability. Prior research has examined the MD&A to examine the information value of additional disclosures. Pava and Epstein (1993) find that the MD&A generally defines past performance. Bryan (1997) shows that the presence of some MD&A topics is allied with future financials, analyst forecast revisions, and current stock returns. However, it is not clear whether the existence of forward looking topics is incrementally more revealing. For example disclosures about capital expenditures are only associated with current stock returns, and none of the forward looking topics is related with changes in future cash flows (Muslu, Radhakrishan, Subramanyam, & Lim, 2015). This result is likely to be due to either the lack of statistical power or the lack of information content of MD&A disclosures.

This paper examines the association between geographic profitability and the quantity of forward looking disclosures. More specifically, I examine if (1) companies with poor profitability environments make more forward looking disclosures and (2) whether forward looking disclosures help increase poor profitability environments. The value of a firm is a function of the anticipated future development and profitability of the firm (Ohlson, 1995). Prior research has established techniques that can be used to improve forecasts of future profitability (Fairfield & Yohn, 2001). Firms with higher profitability, as well as higher

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profits, are more susceptible to regulatory interference (Watts & Zimmerman, 1986). High performing firms should consequently disclose more detailed information in order to justify their financial performance and reduce political costs.

This paper focus on the quantity of forward looking disclosures in the MD&A, differs from those of recent studies, which focus on the tone (i.e., optimistic versus pessimistic) of de MD&A disclosures and segment related sales. Prior research shows that there is an information asymmetry problems related to foreign sales (Hope and Thomas, 2007), and therefore I expect that firm performance should be particularly sensitive to disclosure decisions related to foreign operations. I predict that profitability of foreign sales is related to the amount of forward looking disclosures, and find results consistent with this prediction.

1.2 Research question

Given the elaborate discussion in the introduction the following research question will be answered in this study:

To what extent is the profitability of foreign sales associated with the quantity of forward looking disclosures in U.S. multinational firms?

1.3 Contribution

This paper is increases our understanding of the effect of foreign sales on the level of forward looking disclosures in the MD&A. The quantity of forward looking disclosures is a crucial source of information when valuing a company. Better knowledge about the quantity of forward-looking information can help resolve information asymmetry costs in the capital markets. Prior research investigates the effect of forward looking disclosures in multinational U.S. firms on domestic profits. This research will focus on forward looking disclosure in the MD&A of U.S. multinational firms. From an academic point of view, this research contributes to the existing literature that indicates an association between the foreign segments related sales and the quantity of forward looking disclosures in U.S. multinational firms by providing evidence about the relation among these two and the relation with information asymmetry.

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1.4 Structure

The structure of paper is as follows. In the following chapter there will be a literature review addressed to develop the hypotheses. Matters will be explained and discussed in order to develop the hypotheses. In the third chapter the research methodology will be described. The results of empirical research will be discussed in the fourth chapter. The summary will be in the last chapter, where the results will be discussed and concludes with the limitations of this investigation.

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2 Literature review

The objective of this paper is to examine the interaction among profit margins, forward looking disclosure and information asymmetry. In the literature review in this chapter, I first highlight the importance of disclosure of information on firm profitability for users of financial statements. Then, I discuss a specific type of profitability, the profitability of geographic segments. Second, I discuss the literature on forward looking disclosures. Third, I discuss the Agency Theory. Prior research on these topics will be discussed to develop the hypotheses in chapter three.

2.1 Forward looking disclosures

In this section of the literature review the perception of forward looking disclosures will be introduced. The definition of forward looking disclosures will be provided. Moreover, the quantity of forward looking disclosures will be discussed.

2.1.1 Definition of forward looking disclosure

Forward looking disclosure information discusses to business forecasts about the future of the business state of activities that ultimately offer shareholders valuable information about the company’s forthcoming forecasts. The forward looking information is presented in the company chairman’s report. Company shareholders frequently request information from the management about the future forecast of the company in the sense that what is going to happen to the company in the future; that the management cannot forecast or provide a definite answer to what is going to happen to the company in the future. However, they are in a respectable position to observe most recent market developments and present the shareholders with enlightenments about what the company is planning to do, in spite of the implied comprehension that particular statements of the company’s annual statement are considered speculative. The Security Exchange Commission obligates listed companies to include a disclaimer proviso on all management debates, disputes and discussions with shareholders with the objective to stress this point (Alkhatib, 2014). If and when a disclaimer proviso is stressed properly, the shareholders may well not undertake legal action against the company’s management for providing inaccurate forward looking information (Healy & Palepu, 2001; Kent & Ung, 2003).

Forward looking disclosures contains information about financial forecasts of the company such as revenues prediction, cash flows, and sales volume. Furthermore, it consist of

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information about nonfinancial forecasts such as aspects that might affect the company’s future performance for occurrence risk, future business uncertainty, analysis and evaluation, agency relationship, operations and general appropriate information about the company (Beretta & Bozzolon, 2004; Aljifri & Hussainey, 2007; Uyar & Kilic, 2012). In the most cases forward looking disclosures decrease asymmetry of information between the shareholders and companies that assist involved users or parties making better informed investment decisions (Alkhatib, 2012; Alkhatib & Margi, 2012; Uyar & Kilic, 2012). Therefore, the most superior means of communicating this information to interested users in which forward looking information are presented are the company’s annual reports.

Prior studies on forward looking disclosure have concentrated on forecasting future earnings (Clarkson, Kao, & Richardson, 1994; Frankel, McNichols, & Wilson, 1995; Lev & Penman, 1990). Further studies recognized an association among forecasting future earnings with firm specific characteristic to determine that large sized corporations are probable to offer additional supplementary and high quality information, regarding future earnings than those smaller corporations (Kent & Ung, 2003; O'Sullivan, Rassel, & Berner, 2008). Opposing studies have shown that some companies disclose forecasting future earnings voluntary which may possibly be in order to interest investors to construct informed decision making (Wagenhofer, 1990; Eaton & Stanga, 2000; Dutta & Trueman, 2002; Baginski, Hassell, & Kimbrough, 2004; Lim, Matolcsy, & Chow, 2007; Uyar & Kilic, 2012). Moreover, in disclosing forward looking information there are economic, financial and social benefits (Lang & Lundholm, 1996; Botosan, 1997). Some companies have a tendency to avoid the benefits of insider information and agency relationship by voluntarily disclosing good and bad news equally (Clarkson, Kao, & Richardson, 1994; Hutton, Miller, & Skinner, 2003; Johnson, Kasznik, & Nelson, 2001). Some companies are opposed to disclose forward looking information, for the reason that it has been considered costly and less revealing (Cooke, 1992; Frost & Kinney, 1996; Choi, 1999; Lam & Du, 2004; Leuz & Verrecchia, 2000). Other companies consider forward looking information important, beneficial and significant (Vanstraelen, Zarzeski, & Robb, 2003). Thus, when there is still a high demand for forward looking disclosure information that benefits shareholders and other interested users such as financial analysts, the company should consider performing a cost benefit analysis (Skinner, 1994; Botosan, 1997; Baginski, Hassell, & Kimbrough, 2004; Uyar & Kilic, 2012).

Kent and Ung (2003, p. 283) find that most Australian firms do not provide quantitative earnings forecasts in their annual reports. More than half of the sample discloses forward looking information concerning to earnings, lacking specifically future disclosing

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estimates. Generally, these firms supply qualitative information through a positive preconception, whereas the remnants of the sample disclose no forward looking information concerning to earnings. Managers have incentives to disclose forward looking information to shareholders to support them in their decision making about shareholders’ portfolios. Nevertheless, wherever the earnings of a firm are volatile, there is less inevitability about future earnings. In this case, managers are driven by probable litigation costs or reputation concerns and are less probable to disclose forward looking information. Larger firms are also more likely to provide forward looking disclosures in their annual reports, perchance because of comparatively stable earnings (Kent & Ung, 2003).

2.1.2 Quantity of forward looking disclosures

Public companies are obligated to file MD&A sections as an integral part of their 10-K fillings. Nonetheless, the content of the MD&A sections remains largely voluntary (Beyer, Cohen, Lys, & Walther, 2010). The SEC proposes that the MD&A provide investors with an opportunity to see the company through the eyes of the management and has periodically provided guidance about the content of the MD&A disclosures (Garmong, 2007). Specific, the SEC has highlighted investors’ greater need for forward looking disclosures than for disclosures about past events. It has guided companies to present any known trends, events, commitments, plans, and uncertainties that are likely to materially affect company liquidity, capital resources, or future operations (Securities and Exchange Commission (SEC), 2003). Voluntary forecasts of anticipated trends are also stimulated. Nevertheless, the SEC finds that MD&A disclosures are generally underprovided (Cole & Jones, 2005; Garmong, 2007). MD&A disclosures characteristically contain boilerplate statements and immaterial details but little information of matter (Muslu, Radhakrishan, Subramanyam, & Lim, 2015).

A major association between economic theory and current accounting thought is the perception that a firm´s commitment to greater disclosure should lower costs of capital that arise form information asymmetries. Information asymmetry produce costs by introducing adverse selection trades among buyers and sellers of the firm shares. Adverse selection is classically manifest in reduced levels of liquidity for firm shares. To overcome the unwillingness of prospects to hold firm shares in illiquid markets, firms must issue capital at a discount. Discounting results in lower amounts of capital to the firm and henceforth higher cost of capital (Leuz & Verrecchia, 2000; Copeland & Galai, 1983; Kyle, 1985; Glosten & Milgrom, 1985). The theory is sufficiently broad as to allow the concept of the quality of disclosure (or both). In addition, the theory makes no difference as to how the information

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asymmetries arise (e.g. between a firm and its shareholders, among potential buyers and sellers of firm shares, etc.), the only constraint is that the information asymmetries manifest themselves as a liquidity premium in the price at which trades are accomplished (Muslu, Radhakrishan, Subramanyam, & Lim, 2015). Increased levels of disclosure reduce the probability of information asymmetries arising either between the firm and its shareholders or among potential buyers and sellers of firm shares. In turn, this should decrease the discount at which firm shares are sold, and hence lower the costs of issuing capital (Diamond & Verrecchia, 1991; Baiman & Verrecchia, 1996).

Whereas the theory narrates that level of disclosure and the firm’s cost of capital is convincing, the empirical results have been mixed. Notwithstanding from the complications of measuring the cost of capital directly and assessing this relation, one potential enlightenment for the mixed empirical results between studies using data from firms publicly registered in the United States is that, under current U.S. Generally Accepted Accounting

Principles (U.S. GAAP), the disclosure environment is already rich. Subsequently,

commitments to increased levels of disclosure in the United States are largely incremental, in that way leading to economic significances that are difficult to validate empirically (Leuz & Verrecchia, 2000, p. 92).

Bartov and Bodnar (1996) investigate whether changes in information asymmetry explain more educational accounting choices, while Leuz and Verrecchia (2000, p. 94) challenge to investigate a reduction in the information asymmetry component of the firm’s cost of capital following to the reporting change. Piotroski (1999) discovers that expanded segment disclosures are related with optimistic analysts’ forecast reviews and increase the earnings’ capitalization rate. An essential question in accounting research is how accounting choices are made by managers. Whereas prior examination had demonstrated that variables such a financial leverage and size are essential for explaining cross-sectional variation in accounting choices, one rationale for accounting choice that has acknowledged less thoughtfulness is the information asymmetry perspective. This perspective suggests that value-maximizing managers have incentives to choose more informative accounting techniques to reduce the degree of information asymmetry among market participants (Piotroski, 1999).

Prior studies determines that greater information asymmetry among market participants converts into higher transaction costs and lower liquidity for trading share of the firm, consequently translates into higher transaction costs and lower liquidity for trading

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shares of the firm, therefore raising the required rate of return and lowering current stock prices (Muslu, Radhakrishan, Subramanyam, & Lim, 2015). The information asymmetry perception suggests that managers maximizing firm value will choose accounting techniques, from the set, that reduce information asymmetry to the point where the estimated benefit of additional disclosure is balanced by the estimated costs of making the disclosure. As soon as this symmetry is disconcerted by the introduction of a new occasion for improved disclosure, managers should choose this new technique if the estimated benefit is greater than the estimated costs of application. However, not all firms are equally likely to choose the new accounting method that improves disclosure. Firms with high information asymmetry attempt to reduce it through the adoption of more informative accounting procedures (2002, p. 399).

Prior studies investigated whether forward looking MD&A disclosures provide useful information to the capital markets, and whether voluntary disclosure quality is associated with informative stock prices (Lang & Lundholm, 1996; Lundholm & Myers, 2002; Gelb & Zarowin, 2002). Conversely to the previews, it is not obvious that forward looking disclosures are informative for numerous reasons (Muslu, Radhakrishan, Subramanyam, & Lim, 2015, p. 943). In the analysis of the voluntary disclosure literature, Hirst et al. (2008, p. 329) write: “Managers often issue earnings forecasts to correct information asymmetry problems and, thus, influence their stock price. The idea that earnings forecasts are value relevant was not always obvious, however. Indeed, early research questions whether market participants rely on a forecast form management (i.e., a subjective and unaudited projection of future events)”. Primarily, the MD&A is not a timely channel of communication. Other channels such as press releases, conference calls and analyst-hosted investor conference are timelier and could as a result prevent information communication through the MD&A (Muslu, Radhakrishan, Subramanyam, & Lim, 2015, p. 934). Secondly, investors could rely less on the MD&A than on other parts of the annual report since MD&A sections are reviewed by auditors merely for consistency with the other parts of the annual report (Hufner, 2007). Finally, previous evidence on the lack of MD&A usefulness and the SEC’s related criticism proposes a strong likelihood that forward looking MD&A disclosures are not informative (Muslu, Radhakrishan, Subramanyam, & Lim, 2015). Additionally, voluntary disclosure theories are uncertain about whether managers disclose useful information.

The informativeness perspective expects that managers disclose value-relevant information to lessen the adverse selection problem (Grossman & Hart, 1980; Grossman, 1981; Milgrom, 1981). Subsequent models impose costs and derive selective disclosure

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strategies where managers mostly disclose good news (Verrecchia, Discretionary disclosure, 1983; Dye, 1985). In disparity to the expectations of signaling models, the litigation risk hypothesis rationales that firms voluntarily disclose bad news (Skinner, 1994; Trueman, 1997). Literature discusses that managers disclose either good or bad news to meet investors’ information demands (McNichols, 1989; Lundholm & Myers, 2002; Hutton & Stocken, 2010) or to align investors’ expectations with their own (Ajinkya & Gift, 1984). Generally, the informativeness perspective discusses that voluntary disclosures will be informative even if these disclosures are selective. In disparity, the opportunism perception expects that company disclosures are mainly formed by managers’ motives. Managers disclose good or bad news to the market to “hype” the stock, especially prior to raising capital or extracting rents (Aboody & Kazsnik, 2000; Lang & Lundholm, 2000).

2.2 Profitability

In this section of the literature review the concept of profitability will be introduced. The definition of profit margin will be provided. Moreover, geographical segment profitability will be discussed.

2.2.1 Profit margin

One of the core drivers of profitability is the firm’s profit margin, which is defined as profits divided by total operating revenue. The net profit margin (net income divided by total operating revenue) and the gross profit margin (earnings before interest and taxes divided by the total operating revenue) reflect the firm’s ability to produce a good or service at a high or low cost (Lee & Lee, 2006). Higher profit margins create more net income, larger additions to retained earnings, and faster growth, when all else is held constant. Whenever, growths outpace the planned rate, firms can seek to finance the unexpected growth by raising its process and/or reducing expenses in an attempt to increase its profit margin. If progress falls short the planned rate, the firm could reduce prices, and therefore its profit margin, to stimulate sales.

Research suggests that a firm’s value is determined by the anticipated future development and profitability of the firm (Ohlson, 1995). In investigating financial statements, analysts often use current growth and profitability as preliminary point for forecasting future growth and profitability. The most commonly ratio examined is the return on assets, which is systematically disaggregated into more specific ratios, to provide insights into the firms’ profitability (Fairfield & Yohn, 2001). The most important disaggregation is

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the decomposition of return on assets into asset turnover and profit margin (Brown, Soybel, & Stickney, 1994; Bernstein & Wild, 1998; Revsine, Collins, & Johnson, 1999). Furthermore, calculating the relative contributions of asset turnover (or “asset utilization”) and profit margin (“operating performance”) to existing profitability is valuable in providing insights into the firm’s strategy. Prior research provides evidence on the usefulness of a variety of descriptors in predicting forecasting profitability (Fairfield & Yohn, 2001; Ohlson, 1995; Abarbanell & Bushee, 1997).

As stated in the previous paragraph, the current profitability changes of a firm can be outlined to changes in its assets turnover and changes in profit margin. Changes in asset turnover reveal a change in the productivity of the firm’s asset and would be useful for forecasting future profitability. Therefore, an increase (decrease) in asset turnover would result an increase (decrease) in profitability. A change in profit margin might reveal a change in operating efficiency or otherwise, a change in accounting conservatism. An increase (decreases) in profitability one year ahead arises from increases (decreases) in efficiency since increases (decrease) in profit margin from changes in conservatism should not affect the increased (decreased) profitability one year ahead.

2.2.2 Geographical segment profitability

Hope and Thomas (2007) tests the agency costs hypothesis in the context of forward looking disclosures. This agency costs hypothesis expects that managers, when not monitored by shareholders, make self–maximizing decisions that may not necessarily be in the best interest of the shareholders. Non-disclosure potentially decreases the ability of shareholders to monitor manager’s decisions related to foreign operations (Hope & Thomas, 2007). Hope and Thomas find that non-disclosing firms, comparative to firms that continue to disclose geographic earnings, knowledge greater growth of foreign sales, produce lower foreign profit margins and have lower firm value.

Berger and Hann (2007, p. 3) argues that forward looking disclosures on segment profitability is likely the most valuable piece of information managers might wish to withhold from competitors and investors. Managers face agency costs of segment disclosure if the revelation of a segment that earns low abnormal profits reveals unresolved agency problems and ultimately leads to heightened external monitoring. However, it is important to consider what managers can hide.

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Prior studies provide evidence of the higher information asymmetry related with foreign operations compared to domestic operations (Thomas, 1991; Denis, Denis, & Yost, 2002; Khurana, Pereira, & Raman, 2003; Thomas, 2004; Callen, Hope, & Segal, 2005; Tihanyi & Thomas, 2005). This can be caused by managers who grow the firm by moving into unprofitable or less profitable foreign markets. While the firm grows, managers are not obligated to disclose reduced profits of the foreign segments. Firms are still obligated by SEC Regulation §210.04-08 to disclose total foreign and total domestic income, these profits can be aggregated into a total foreign income number. It is not possible for investors to oversee whether lower profits occur as a consequence of existing foreign operations or as a consequence of managerial decisions related to expanding foreign operations, when total foreign profits decline.

The confirmation on the usefulness of geographic earnings disclosure under SFAS 14 is to some extent mixed. Boatsman, Behn and Patz (1993) discovered that such disclosures are useful, nevertheless only for firms with large variations in profitability. Ahadiat (1993) uses a Box-Jenkins time series model on a limited sample and determines that such disclosures are valuable in predicting consolidated earnings. Thomas (2000) reveals that SFAS 14 geographic earnings disclosures are value significant. Finally, Hope and Thomas (2007) demonstrate that disclosure of geographic earnings following the implementation of SFAS 131 is positively related through the pricing of total earnings from foreign operations.

2.3 Agency theory

In this section of the literature review the theory of agency costs will be introduced. The definition of agency costs will be provided. There will be description of reasons for agency costs. Finally, constraints of agency costs will be discussed.

2.3.1 Definition of agency theory

Agency theory has been one of the most important theoretical paradigms in accounting during the last 20 years (Lambert, 2001). Jensen and Meckling (1976) define an agency relationship as a contract under which one or more persons (the principal) engage another person (the agent) to perform some service on their behalf, which involves delegating some decision making authority to the agent. If both parties to the relationship are utility maximizers, there is good reason to believe that the agent will not always act in the best interest of the principal. The principal can limit divergences from his interest by establishing appropriate incentives for the agent, and by incurring monitoring costs designed to limit the aberrant activities of the

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agent. In addition, in some situations it will pay the agent to expend resources (bonding costs) to guarantee that he will not take certain actions which would harm the principal, or the ensure that the principal will be compensated if he does take such actions. However, it is generally impossible for the principal or the agent at zero cost to ensure that the agent will make optimal decisions from the principals’ viewpoint. In most agency relationships, the principal and the agent incur positive monitoring and bonding costs, and in addition there will be some divergence between the agent’s decisions and those decisions, which would maximize the welfare of the principal. In the analysis of Jensen and Meckeling (1976, p. 323) they show how to control for the potential behavior of the owner-manager through monitoring and other control activities. In these models they include auditing, formal control systems, budget restrictions and the establishment of incentive compensation systems which serve to more closely identify the manager’s interests with those of the outside equity holders shows the effect of monitoring and other control activities. By incurring monitoring costs, the equity holders can limit the manager’s consumption of incentives.

Information asymmetry and agency problem lead to inefficient allocation of resources in the capital market. Consequently, efficient contracts among agents and principals are used to solve these difficulties and increase agent’s inventive for disclosure of information. As an outcome of this process, misevaluation of the firm is reduced and conflicting interests are tuned to be congruent (Shiri, Salehi, & Radbon, 2016). Environmental and economic factors besides with financial characteristics of firms hinder information asymmetry and agency problems to be solved entirely (Jensen & Meckling, 1976).

The agency cost hypothesis predicts that when managers are monitored less, they are more likely to make suboptimal decisions (Hope & Thomas, 2007). Suboptimal decisions eventually lead to lower reported total earnings, which must be disclosed by all firms, causing firm values to decline. At some point, the valuation penalty is internalized by the manager. However, some of these penalties can be delayed with the help of strategic disclosure. Nondisclosures do not report specific geographic earnings, making it more difficult for investors to know whether poorer performances relates to normal business operations (i.e., existing operations or events external to the manager’s control) or to the manager’s decision to expand in certain foreign areas. Thus, nondisclosure of geographic earnings does not preclude poor performance from eventually being reported in total earnings, but nondisclosure does make it more difficult to monitor whether performance relates to poor managerial decisions. In summary, we show that nondisclosure is associated not only with lower reported

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accounting performance but also with real economic losses, as measured by the decrease in firm value (Hope & Thomas, 2007, p. 604).

2.3.2 Agency cost and segment reporting

The main challenge for well developed markets is optimum allocation of savings to current investment opportunities. Regularly, the most firms and entrepreneurs who are willing to attract capitals for commitments of applying their business concepts. Whereas both shareholders and practitioners are willing to operate business activities, similar resources to investment opportunities in the business sector are highly complex for two motives. Primarily, managers have a better understanding about the value of investment opportunities than the investors; they also have more incentive to overemphasize the value of their firms. Second, after investors have devoted their money in a firm, managers have an incentive to use their investment in an unsuitable way, so that the agency problem appears (Beyer, Cohen, Lys, & Walther, 2010; Healy & Palepu, 2001).

Managers may announce a management forecast to make available information that is otherwise held by only a subset of investors (Coller & Yohn, 1997). Assumed the restricted set of items that are disclosed in segment footnotes, segment profitability is likely the furthermost valued piece of information managers might wish to withhold from opponents and investors. On the other hand, managers face agency costs of segment disclosure if the exposure of a segment that earns low abnormal profits exposes unanswered agency problems and eventually leads to intensified external monitoring. Earnings (deflated by segment sales or assets) are possibly the most important measure in evaluating the segment's performance. Berger and Hann (2003) make a descriptive evidence available that while LOB revenues are frequently obtainable in the management discussion and analysis (MD&A) section of a company's 10-K, earnings figures are usually originate merely in segment disclosures. Henceforth, hiding segment profits likely the main reason for managers to aggregate segment information. From the agency cost perspective, the occurrence of a poor or inefficient cross segment transfers. Individually reporting such a segment might consequence in heightened external scrutiny. Therefore, managers have agency cost motives to withhold segments with relatively low abnormal profits (Berger & Hann, 2007).

Previous to the issuing of SFAS 131, every multinational firm was obligated to disclose profits, sales and total assets by geographic area and to reveal their line-of-business information (Berger & Hann, 2007, p. 870). After the implementation of SFAS 131 every firm was still obligated to disclose total assets and sales, but disclosure of geographic earnings

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was now at the discretion of the firm (Hope & Thomas, 2007, p. 582). As mentioned above some firms stopped reporting profitability for their geographical segments after the adoption of SFAS 131 (Herrmann & Thomas, 2000). This implementation enlarged the information asymmetry. In SFAS 131 firms have less discretion over the number of segment. This lower discretion over disclosures of segments leading to disaggregation may have significances for the agency costs. Moreover, suggesting that managers avoided revealing poorly performing segment information under SFAS 14, constant with the agency cost hypothesis. Berger and Hann (2007) show that new segments under SFAS 131 are related with lower abnormal profits than the old segment under SFAS No. 14.

Relating to the information asymmetry between managers and financial statement users, Dutta and Trueman (2002) showed that managers do not base their disclosure decision on their own understanding of the private information, but rather on their prediction of how the analyst will understand it. If the analyst’s preceding valuation of the firm is favorable, the manager is willing to disclose information regardless of his own assessment of its valuation, even if managers personally find information unfavorable. They expect the analysts to understand the information in a favorable manner (p. 77). The results suggest that disclosures strategies will be contingent on the market’s preceding valuation of the firm, as it informs them how investors will understand forthcoming disclosures. Moreover, the disclosure strategy can no longer be considered as a single good versus bad news divider of the managers’ private information (p. 86). If the analysts’ previous valuation prediction of the firm was favorable, the manager will disclose either adequately favorable or adequately unfavorable information that is in accordance with the analysts’ previous valuation. However, the analyst had previously released an unfavorable assessment of firm value, then information that it either favorable or unfavorable will be withdrawn. The disclosure strategies are consequently, driven by the manager’s assessment of the analyst’s valuation of disclosed specifics and not his own.

Prior studies showed that firms with more investment opportunities had lower financial reporting quality and were more likely to have lower level of accounting disclosures (LaFond & Watts, 2008). Contrariwise, for the period of the finalization of investment projects, when the firm’s potential for future growth is lower, information asymmetry could reduce and, therefore, the quality of financial reporting could improve.

According to the monitoring hypothesis, presence of institutional investors and major investors among shareholders of the firm (ownership concentration) can decrease information asymmetry. In turn mitigate agency costs, mostly due to the monitoring role of these

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investors. Conversely, based on self-interest hypothesis, institutional investors and major investors have additional incentive for retrieving private information about the firm for their transaction purposes. Consequently, these investors are not as much interested in disclosure by the firm. Hence, are possible to increase information asymmetry and in turn increase agency problems (Jiang, Habib, & Baiding, 2011). Statistical results derived from the investigation of Shiri, Salehi and Radbon (2016, p. 59) have shown that positive (direct) and negative (reverse) impacts of ownership structure and disclosure quality on information asymmetry, respectively. These outcomes suggest that information asymmetry is more in firms which have major shareholders, higher level of institutional ownership, and lower disclosure quality related to other firms. General results are consistent with the self-interest hypothesis.

2.3.3 Information asymmetry

Research has shown that it is necessary to disclose information in order to reduce information asymmetry among a company and its stakeholders (Nayak, 2012). There are many different types of information, including strategic information, financial information, social information, environmental information, and stock price information. Constitutional disclosure may perhaps not meet the information demand of modern society. Societal changes make different information demands for companies to respond to, which affect the approach companies communicate to their stakeholders and the business environment. Firms disclose additional (voluntary) information in order to reduce such information gaps. Niléhn and Thoresson (2014) studied the variables affecting the magnitude of corporate voluntary information in Sweden. Findings showed asymmetric information as important determinant to the extent of strategic corporate information, that is, voluntary information. Larger firms seemed to narrow the information asymmetry by increasing the level of information disclosed.

The determination of the annual report is to decrease the informational distance between the company and the stakeholders. The annual report has hence the ability to reduce information asymmetry (Petersen & Plenborg, 2006). Information asymmetry is defined as flawed knowledge in decision making, particularly when one party has diverse (more or better) information than the other. Furthermost, information asymmetry is studied in the setting of principal-agent problems. When information asymmetries occur, disclosure decisions made by managers can affect stock prices because information asymmetries between more informed and less informed investors rise transaction costs and reduce estimated liquidity in the market for a firm’s shares. Managers’ disclosure decisions may also

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affect stock prices when they have contracting or tax implications. These associations amongst information asymmetry, trading liquidity and stock price have been developed by prior studies (Copeland & Galai, 1983; Glosten & Milgrom, 1985; Diamond & Verrecchia, 1991).

Managers delay disclosure of bad news relative to good news (Kothari, Shu, & Wysocki, 2009). Prior research concludes the relative timeliness of bad and good news disclosures from the extent of stock price reactions to such disclosures. A variety of incentives, including career concerns, motivates managers to withhold bad news up to a certain threshold, nevertheless rapidly disclose good news to investors. The extent of negative stock price reaction to bad news disclosures is greater than that of the positive stock price response to good news disclosures. The tendency of managers to withhold bad news can stem from a standard agency problem where managerial disclosures preferences are not aligned by those of shareholders. Managers naturally have greater private information compared to the investment community. Several incentives can motivate managers to disclose or withhold their private information (Healy & Palepu, 2001; Verrecchia, Essays on disclosure, 2001). Managerial commitment to quickly reveal private information, good or bad, can lessen information asymmetry and possibly lower the firm’s cost of capital (Glosten & Milgrom, 1985; Diamond & Verrecchia, 1991; Verrecchia, 2001; Healy & Palepu, 2001).Contracts between managers and investors that guarantee upcoming non-mandated disclosures are usually not observed in practice (Bartov & Bodnar, 1996, p. 400).

Due to the limited flexibility of the required reporting technology, firms that operate in environments of varying complexity have different degrees of information asymmetry. Information asymmetry amongst market participants interprets into higher transaction costs for trading shares of the firm. Higher transaction costs lower the current stock prices. Managers desiring to maximize the value of their firm will have incentives to decrease the degree of information asymmetry between market participants through switching to new accounting techniques that make financial statements more informative to investors (Bartov & Bodnar, 1996, p. 416). Given appropriate compensation contracts, it is probable that managers act as rational, value- maximizing economic agents and choose disclosures from the available set based on the expected benefits and costs (Christie & Zimmerman, 1994).

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2.4 Confirmation hypothesis

In this section of the literature review the theory of confirmation hypotheses will be introduced. The definition of confirmation hypotheses will be provided.

2.4.1 Definition of conformation hypothesis

As elaborated in the previous sections, this study attempts to give inside in to the extent of which firms disclose more forward looking disclosures to compensate for low quality segment information. The hypothesis suggests that audited financial reporting and voluntary disclosure of managers’ private information are complementary mechanisms for communicating with investors, are not substitutes. Ball et al. (2012) previous study argues that the primary (but not exclusive) role of financial reporting is to supply auditable financial outcome variables for use in efficient contracting with the firm, including providing of a mechanism through which managers can credibly commit to disclose truthful private information to users. Voluntary disclosure of information that is privately known only to managers has a primarily informational rather than contracting role. Managers seeking to provide informative disclosure of private information therefore need a mechanism for credibly committing to be truthful. Ball et al. (2012) propose that committing to the provision of high-quality audited financial statements is one such mechanism. This mechanism works as follows. Reporting ex-post financial outcomes (such as revenues, earnings and total assets) that are both accurate and independent of management manipulation permits outsiders (such as boards, analysts, lenders and investors) with a means of evaluating the truthfulness of past management disclosures. In turn, the expectation that actual outcomes will be accurately and independently reported serves to discipline managers to make more truthful and hence more informative voluntary disclosure ex ante (2012, p. 136). Financial reporting based on independently verifiable information allows managers to implicitly contract (commit) to truthfully disclose unverifiable information. This complementarily in role implies that financial reporting is an input to the firm’s total information environment, and that it only can be designed and evaluated by its contribution to the efficiency of the complete system of communicating with investors and other users. This complementary relation is termed the ‘‘confirmatory role’’ of financial reporting.

Moreover, enhanced understanding about the credibility of forward-looking information can help resolve agency conflicts in the internal capital markets. Investors and other users of financial information can make better investment decisions because of this, therefore it improves investment efficiency. Failure to disclose earnings at a disaggregated geographic

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level decreases shareholder’s ability to monitor managers’ choices associated to foreign operations. A lot of the previous literature is dedicated to and constant with the agency cost hypothesis that suggests that disclosures are withheld as a consequence of conflicts of interest between shareholders and managers (Berger & Hann, 2007, p. 870).

Prior study examined how the content of the firm’s financial reports, affects what the managers voluntarily discloses. Particularly, if the reports contain sufficiently good (bad) news, the managers disclose small (large) values of her private information and otherwise do not provide a voluntary disclosure (Bagnoli & Watts, 2007). Naturally, when the manager knows the difference is small, she knows that the content of the financial reports mainly reflects permanent rather than transitory effects. Thus, if they contain good news, she increases their value impact by voluntarily disclosing her private information when she knows that the variance is small. If they contain bad news, she minimizes their impact by disclosing her private information when she knows that the variance is large. Moreover, if the reports just meet market expectations, managers do not provide any information about the permanent and transitory components (p. 887).

Furthermore, Dutta and Trueman (2002) show that decisions to disclose voluntary information does not depend on whether the information in the mandatory disclosure contains good or bad news. Presuming that this is the case, I expect that managers will make voluntary disclosures available to compensate for the absence of information on segment profitability.

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3 Development Hypotheses & Research Methodology

This research question will be answered through a quantitative research. First the hypotheses development will be elaborated. Moreover, the dataset and the sample will be explained. Also there will be an elaboration of the method that is going to be used for this research.

3.1 Hypotheses development

Based on the studies presents in the prior section I predict that profit margins are associated with the quantity of the forward looking discourses. The variables in this research are established. Profit margins of foreign sales will be the independent variable. The quantity of forward looking disclosures will be the dependent variable. I predict that there will be an association with more forward looking disclosures in U.S. multinational firms, and profit margins. Therefore, I developed the following hypothesis about the profitability of foreign sales and forward looking disclosure.

Hypotheses I: Lower profit margins are associated with more forward looking disclosure in U.S. multinational firms.

The previous literature review shows that throughout lower profit margins, there are more information asymmetry costs and therefore, more bad forward looking disclosure. I predict that good looking forward disclosure will be lower than bad forward looking disclosure, compared to when there are lower profit margins.

Hypotheses II: There is more bad forward looking disclosure than good forward disclosure, when there are lower profit margins.

In the next sections, I will address the methodology to answer the research question. The model used to evaluate the association of profit margins of foreign sales with the quantity of forward-looking disclosures in U.S. multinational firms.

3.2 Data & Sample description

This study examines to what extent profit margins of foreign sales is associated with the quantity of forward-looking disclosures in U.S. multinational firms. The dataset is obtained from the University van Amsterdam. It is a unique dataset a lot of prior studies are often narrowed to a small sample size. It consists of forward looking sentences on foreign operations. These sentences are often qualitative in nature. These sentences have been

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extracted from MD&A sections of 10-K filings, using automated language processing techniques. This sample consists of 2090 U.S. multination firms engaging in geographical segment reporting (i.e. firms that have at least two geographical non-U.S. segments) for each of the five years. This dataset is manually classified. After the manual classification of sentences, final sample consists of U.S. firm-years from years 1996 to 2000, with information on forward looking sentence, the number of forward looking sentences on foreign segment operations per firm- year. Classifications will be made into number of good news forward looking sentences, number of bad news forward looking sentences and number of neutral forward looking sentences to investors. Furthermore, these classifications will also be made into number of forward looking sentences on foreign segment sales, costs, profits and management actions (investments). Further information in the dataset are total assets, long term debt, pretax income, standard industrial classification, total assets, total foreign segments and total business segments. Additional data is extracted form COMPUSTAT and Execomp. STATA will be used for this research to exercise descriptive and regression with this set.

3.3 Variables

The variables that are tested in the correlation matrix and regression are distinguished in independent variable and dependent variable. The independent variable is the profitability of foreign sales, which are the profit margin ratio and the profitability ratio. The dependent variable is the voluntary forward looking disclosure, to measure this variables the quantity of the forward looking disclosures will be used. Managers may possibly want to hide bad news whenever this news exposes negative consequences of managers’ decisions in strategy and actions of the company.

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The forward-looking sentences form the MD&A sections are extracted from the 10-K fillings, using automated language processing techniques. This is useful when analyzing the nature of the forward looking sentences. Analyzing the MD&A into sentences in addition to use the sentences as the unit of analysis instead of words of text lines, for the reason that a sentences is the smallest essential unit of text that expresses an idea or message (Ivers, 1991). The MD&A sentences are identify as forward looking sentence (FL_GEO) if the sentences included any of the following phrases, stems: “will”, “should”, “can”, “could”, “may”, “might”, “expect”, “anticipate”, “believe”, “plan”, “hope”, “intend”, “seek”, “forecast”, “objective”, “goal”, “project”. This is the same list as examined in the investigation of Li (2010). The MD&A sentences are identify as foreign sentence if the sentences included any of the following phrases, stems:, string out of: country list provided by GATE, region list provided by GATE, country adjusted list provided by GATE: “outside North America” (FL_FOREIGN), “inside North America” (FL_NA), “in U.S.” (FL_US), “in Canada” (FL_CA). List items related to the U.S. are deleted form the initial GATE list. The MD&A sentences are identify as operation (FL_PROFITS) sentence if the sentences included any of the following phrases for (1) sales: “revenue”, “sales”, (2) profits: “profits”, “loss”, “earnings”, “income”, “margin”, “EBIT”, “EBITDA”, “EBITA”, “eps”, “operating results”, “result of operations”, “operating performance”. The MD&A sentences are identify as news sign if the sentences included any of the following: positive news about future disaggregated operations (FL_GOOD), negative news or caution about future disaggregated operations (FL_BAD), no/neutral news about future disaggregated operations (FL_NO).

3.4 Method

This research starts with testing whether the profit margins of foreign sales have an impact on quantity forward looking disclosure in U.S. multinational firms.

In the Encyclopedia of Finance the definition of profitability ratios is defined as the ability of a firm to use its sales, assets and equity to generate revenues. Profitability measures a company’s earnings net income against total net assets. Profitability has shown a significant relation with the level of disclosure. Firms with high profits are likely to disclose more information and give signs good performance in order to interest investments and increase shareholders confidence (Inchausti, 1997; Aljifri & Hussainey, 2007; Alkhatib, 2012; Uyar & Kilic, 2012). Under SFAS 131 managers can withhold information about segment operations (Hope & Thomas, 2007, p. 589). Managers are less accountable for segmental

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profits. The usefulness of disclosing geographic earnings beyond aggregated total foreign earnings is referred to in paragraph 105 of SFAS 131 (Financial Accounting Standards Board, 2007), which stated “Information disclosed by country is more useful because it is easier to interpret. Research suggests that a firm’s value is determined by the anticipated future development and profitability of the firm (Ohlson, 1995). In investigating financial statements, analysts often use current growth and profitability as preliminary point for forecasting future growth and profitability. The most commonly ratio examined is the return on assets, which is systematically disaggregated into more specific ratios, to provide insights into the firms’ profitability (Fairfield & Yohn, 2001). The most important disaggregation is the decomposition of return on assets into asset turnover and profit margin (Brown, Soybel, & Stickney, 1994; Bernstein & Wild, 1998; Revsine, Collins, & Johnson, 1999).

The profit margin, or return on sales, represents the proportion of each sales dollar that becomes profit or net income to the firm (Lee & Lee, 2006). The profit margin is computed as, net income divided by sales. Higher profit margins lead to creating more net income. This indicates that the company is able to increase its business through the achievement of operating profit in the period. With the achievement of these earnings, investors will get a positive picture of the performance of the company so that investors can expect a high return on its equity. Therefore it can be said that earnings growth will also increase. Consistent with the predictions of the information asymmetry hypothesis Hope and Thomas (2007, p. 594) find that nondisclosure of foreign earrings is associated with a significant increase in foreign sales growth and a significant decrease in foreign profit margin. This means that as the ability of shareholders to monitor managers diminishes because of nondisclosure of foreign earnings, managers are more willing to expand their international operations, even though such actions lead to lower firm performance. Furthermore, firms with higher foreign sales growth have, on average, higher profit margins compared to firms with lower foreign sales growth (Hope & Thomas, 2007, p. 603). However, firms that no longer disclose foreign earnings have lower foreign profit margins even though they have greater foreign sales growth. This result concludes that nondisclosure reduces monitoring of managerial decisions, allowing managers to inefficiently expand foreign operations, which reduces foreign profitability.

3.4.1 Regression model

A model of the linear regression analyses was developed to measure the relationship between the forward looking information and the explanatory variables used in this study. The model is formulated as follow:

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TOTAL FLD= α + β1 PROMARGIN + β2 PROFITABILITY+ β3 FORSALSES + β4 SIZE + β5 DEBT+ β6 SEGDIVERISTY + β7 LEVERAGE

Where:

TOTAL FLD= the quantity of good and bad forward looking disclosures Β1 PROMARGIN = Foreign profit margin, net income/ sales

β2 PROFITABILITY = Firm return on total assets, net income/ total assets. β3 FORSALES = Firm total foreign sales

β4 SIZE = Firm size measured by total company assets β5 DEBT = Firms total debt, In of debt

β6 SEGDIVERISTY = Segment diversity, total business segments, measured in scales β7 LEVERAGE = Firm leverage measured by total liabilities/total assets

3.4.2 Control variables

Several control variables are used in this research: the foreign sales of the firm

(FOREIGNSALES), the size of the firm (SIZE), the debt of the firm (DEBT), the diversity in

the segment (SEGDIVERSITY), and the leverage of the firm (LEVERAGE).

The firm size variable is used in almost all prior studies on information disclosure. It is a proxy of a firm’s total assets. Large sized firms have a tendency to disclose more information than smaller ones (Uyar & Kilic, 2012). Additionally, studies recognized an association between company size and the level of disclosure (Alkhatib, 2014; Wallace, 1988; Clarkson, Kao, & Richardson, 1994; Aljifri & Hussainey, 2007; Uyar & Kilic, 2012; Alkhatib, 2012). Foreign sales percentage of sales from foreign operations. It controls for the relative importance of foreign operations across the sample firms. Size is a standard proxy for the firm’s overall disclosure level (Lang & Lundholm, 1996), and this it controls for the other disclosures provided by firms. The debt of the firm shows the position of long term debt. Whenever a firm has a lot of debt this possibly will increase the opportunity to withhold forward looking disclosures. Management possibly wants to withhold information about the sales and profit since this could have negative consequences for the organization and creditors. Whenever a firm has a lot of debt and high sales and profits their investors and financial statements users might requests the firm about their operations. The debt ratio is used by calculated by In of the debt. Lee and Lee (2006) investigated the relation between the profitability and the debt ratio. In the pecking order hypotheses firms that have high profitability should have lower debt ratios, as these firms’ additions to retained earnings reduce their need to borrow. In the static tradeoff hypothesis, firm’s that have high profitability ratios should have a lower profitability of bankruptcy and a higher tax rate, hence

The effect of profitability of foreign sales on the quantity of forward looking disclosures of U.S. multinational firms

Amsterdam Business School

Master thesis