NONDISCLOSURE – A GOOD NEWS SIGNAL?

I examine the implications of nondisclosure in a setting where there is a credible signal as to the proprietary nature of the undisclosed information. Specifically, I investigate the market and analysts' response to firms’ application to the Securities and Exchange Commission (SEC) for a confidential treatment order (CTO), which allows firms to redact required disclosures from SEC filings when the redacted information is proprietary. I find that the market and analysts react favorably to the voluntary nondisclosure of proprietary information using the SEC confidential treatment process. Market and analysts reactions are more favorable to the redaction of information that is more likely to have proprietary value, such as information related to research and development. In addition, I show that the redacting firms experience superior accounting performance compared to their peers in the years following the redaction, consistent with the market and analysts’ response to the redaction. However, I find that analysts engage in more intense private information search in response to a CTO redaction. This finding suggests that, although a CTO redaction can signal the nature of undisclosed information, analysts believe that the signal is not fully revealing of the economic magnitude of the undisclosed information. Overall, this study’s findings indicate that a firm's willingness to submit to the CTO approval process serves as a credible signal of the proprietary nature of the withheld information. The results of this study suggest a possible role for a credible signaling channel to facilitate communication between insiders and outsiders regarding the nature of withheld information.

Industry Linkages and Audit Firms' Industry Portfolio Choice: Evidence from Product Language

Audit firms are organized along industry lines and industry specialization is a prominent feature of the audit market. Yet, we know little about how audit firms make their industry portfolio decisions, i.e., how audit firms decide which set of industries to specialize in. In this study, I examine how the linkages between industries in the product space affect audit firms’ industry portfolio choice. Using text-based product space measures to capture these industry linkages, I find that both Big 4 and small audit firms tend to specialize in industry-pairs that 1) are close to each other in the product space (i.e., have more similar product language) and 2) have a greater number of “between-industries” in the product space (i.e., have a greater number of industries with product language that is similar to both industries in the pair). Consistent with the basic tradeoff between specialization and coordination, these results suggest that specializing in industries that have more similar product language and more linkages to other industries in the product space allow audit firms greater flexibility to transfer industry-specific expertise across industries as well as greater mobility in the product space, hence enhancing its competitive advantage. Additional analysis using the collapse of Arthur Andersen as an exogenous supply shock in the audit market finds consistent results. Taken together, the findings suggest that industry linkages in the product space play an important role in shaping the audit market structure.