Business Times - 27 Jul 2009
BT-NBS ROUNDTABLE
Panellists fron NTU's Nanyang Business School
Hwang Chuan Yang, Professor of Finance, and director of Research and PhD Programme
Thomas Noe, Visiting Professor of Finance and the Ernest Butten Professor of Management Studies at SaÃd Business School in Oxford University
Lilian Ng, Visiting Professor and the Hans Storr Professor of Finance at the University of Wisconsin in Milwaukee
Qian Xiaolin, Ph D researcher working on a finance dissertation on Information Risk
Moderator: Narendra Aggarwal, director, public affairs, Nanyang Business School
--------------------------------------------------------------------------------
OVERVIEW
STOCK markets around the world have rallied significantly in the first half of this year, erasing much of the losses suffered since last September's financial meltdown. For instance, the Singapore stock market saw a 38.7 per cent surge in its market capitalisation to $545 billion at end-June, a 10-month high since last August and shortly before the Lehman Brothers collapse sparked a stampede out of equities globally.
In an ongoing Nanyang Business School-Business Times Roundtable discussion series, senior professors and a research scholar at Nanyang Technological University's business school look into the issue of information risk and its impact on stock market investors and practitioners like stock analysts, portfolio managers, stock remisiers and dealers.
Narendra Aggarwal: As we start the discussion, how does the information flow on listed companies usually take place and get shared among the market players - both individuals and institutional investors - and the practitioners?
Lilian Ng: Primary information on listed companies depends on the general information environment of a country as well as that of a firm. Generally, it depends on how firms channel their information to the public, either through their earnings announcements or through various other company announcements from time to time.
The market also gets a lot of information through analysts following the firm. My research has shown that analysts following the firm have to really reveal a lot of information about the firm. For firms that have many analysts following them, generally very little private information is revealed in the trades of the stocks. This is because a lot of information about them is already known publicly. That helps in the sense that firms become more transparent, which is good for the market.
Thomas Noe: I would like to add that information also flows the other way as you get information from the markets going to the firms. Stock prices affect the firm's decisions. My research has shown that this leads to higher efficiency. If you have a liquid stock market and highly appropriate prices, firms operate better and choose better policies. So, the flow is bidirectional between the markets and the firms, rather than just the firms revealing information to the markets.
There are a huge number of analysts and traders both on the buy and sell sides, as also private investors who speculate in stocks, who gather their own information. For instance, if you have a consumer products company, it may have better information about its production technology, whereas the market may have a better understanding of the demand for its products. These people investigate and in making their stock picking decisions they affect the stock prices, thus sending signals back to the firm thereby helping it to make better decisions.
Hwang Chuan Yang: The firm learns the information from its stock price so that it can allocate the resources more efficiently and aim to run itself better. That is why it is important to create the environment so that all the correct information comes to the market as quickly as possible and gets reflected in the stock price.
In fact some people argue that even the information that insider traders might have comes to the market through their trading activity and soon the wider market is better informed about the firm.
Similarly, when a firm announces an investment decision and its stock price goes down, this means that the market thinks that the investment may not be such a good idea. On the other hand, if the price goes up, it is an indication that the firm may have some intangible assets which are being factored into its stock price. This reverse information flow from the market to the firm may in fact encourage the managers to issue more stock in view of the high price to raise more capital and go in for more net investment.
Qian Xiaolin: Actually the information is split into public and private information. The public information is available to everyone in the market which can be through the firm's public disclosure or through informed traders as their trading actions makes the information available to all.
Private information can come from insider information and also from skilled investors like financial analysts and portfolio managers who may have analysed the public information using their professional skills and interpreted it better compared to lay investors. And they can disclose that information to the market and make the price more informative. The skilled investors can also generate information from the whole industry and the broader economic environment of the country and thus help the manager to make better decisions in the investment or the financial policies of the firm.
Mr Aggarwal: Companies sometimes try to hide unfavourable news about their activities and performance. How does the market keep itself well informed and try to get as much news as quickly as possible?
Prof Ng: There are two ways for firms to disclose information - voluntary and regulatory. Firms often release information for investors to know about their firm so that they have more faith in them or when they may want to raise equity.
Firms also make regulatory disclosures on a periodic basis as may be required by law. Studies have shown that firms that make more reporting of financial information find that helps to reduce the cost of capital. It is important for a firm to know that the more information the public has about the firm, not only does that help to reduce the cost of capital (i.e., the financing cost) but it also raises the value of the firm.
My research has shown that analyst coverage helps reduce the amount of private information pertaining to a firm and also helps increase the efficient allocation of the firm's resources by having analysts reveal more information about the firm, compared to a firm with no analyst coverage. This is a critical component of having more information transmitted to the public.
Firms with no analyst following are typically more opaque. They tend to have problems in terms of raising money. Their accounting information is generally perceived to be less credible by the public, and this will affect their cost of capital, making it higher compared to that of firms with wider analyst coverage.
Prof Noe: Another benefit from analysts' following a company is that it increases interest in the stock, which increases the amount of uninformed trading by people who do not have information in the company. This is very useful as you need to have uninformed traders for informed people to make any money in the market. This increases liquidity of the stock in the market. Singapore firms that do not have analysts following them need to do something about it to get analysts to follow them on a regular ongoing basis.
Ms Qian: Besides having analysts' following, firms can also make themselves more available when there is increased institutional holding because the average investor may look at whether institutions are investing in them or not. Because the institutional investors are more skilled, they may have had their own analysts look into the firm's financial data, so the other investors can take a free ride. I would like to suggest that when institutions invest in a firm, it should take advantage of that by releasing the information to the investing public to create more interest in its stock.
Prof Noe: I am not sure if this happens in Singapore, but it does take place elsewhere. For instance when Warren Buffet buys a stake in a firm, it gets trumpeted. When he invested in an Israeli steel company a few years ago, the company released the information and it was front page news. It was Mr Buffet's first investment outside the United States and the Israeli company used it to its advantage by disclosing it. This created interest in the firm among other investors in the market and boosted its value.
Prof Ng: I think the same happens when Temasek or GIC invests in a firm at home or abroad. A lot of people get interested in those firms just by reading in the newspapers that these big funds have invested in them. I know that individual investors including laymen get interested in firms whose stocks are held by Temasek. This is because Temasek is considered a sophisticated and sound investor, and the individual investors would want to ride on information they think it has.
Prof Hwang: Actually more information disclosure by the firm and the analysts helps the investor to have a more level field in the sense that any adverse information about the firm gets known to all in the market and gets factored into the stock price.
In the United States, under Federal disclosure laws, a company cannot engage in selective disclosure of advance information to analysts or certain types of investors as used to happen in the past. Under the SEC's rules, now all information has to be released publicly by a listed company simultaneously to all in the broader market.
Ms Qian: The affect of this law is very interesting. While for the larger firms it reduces the information gap and the cost of capital, for smaller firms sometimes the cost of public disclosure can be quite high and this could discourage them from releasing information. Thus with the route of selective disclosure to analysts closed for smaller firms, they do not replace it with public disclosure due to the cost factor. The result is that there is less information available about the firm to investors in the market and the stock price may become less liquid as a result of the uninformed investors moving out of the market.
Mr Aggarwal: How can companies reduce the negative impact of adverse news on their share price? What suggestions would you like to make for firms to better manage the information risk from unfavourable developments on their stock trading?
Prof Ng: Sometimes companies wait till the last day of the trading week or even the close of trading for the week to make announcements, so that investors have the whole weekend to absorb the news and do not over react and engage in panic selling. This results in what some people call the Weekend affect. When trading resumes on Monday, the impact on the share price will not be as big as it would have been if the news had been released during the trading week.
To manage the likely impact from bad news, in the United States firms often drag their filings to the end of the earnings season and ask for extension of the results filing date to prepare the market for the announcement.
Prof Hwang: At this point I would like to highlight the risk from unsubstantiated rumours about the firm or, say, the health of its CEO or senior management that sometimes enter the marketplace. Given that information - be it good or bad - impacts the stock price, the firm should try to release as much information as possible to the market instead of the market having to react to speculation or unfounded rumours.
Generally, I would advise companies to have a strong public relations team to get as much information as possible to the market and be more transparent as opposed to being opaque. The bottomline is that creating a more level playing field for all investors through more information is better for the market and the stock price of the firm.
Ms Qian: Actually more information helps the investors to be more confident about the company. Even in bad times if the firm does not disclose enough information about itself, this can cause panic among investors as they can somehow sense that things are not going well for the company and this may result in more panic in the whole market.
The danger is that if a firm facing problems does not disclose what is happening and, say, some institutional investors sell the stock for whatever reason, including stock balancing, uninformed traders watching the informed traders' behaviour, might follow those traders and suddenly start selling and that could cause a price crash which would be bad for the company. Sometimes it may even cause the whole market to crash if the situation is bad.
Prof Noe: In managing information flows to the market, there is a downside to too strict enforcement of rules. For instance, if the manager of a firm is making a forecast of earnings and if he thinks he has some legal liability if he makes a mistake, he may decide not to make a forecast at all. Or he may end up giving a wide range so as to cover himself against any future liability which in a way defeats the very purpose of the forecast serving as a guide to the market.
Mr Aggarwal: What steps can be taken to reduce the information risk so that stock trading is encouraged and the market becomes an even better allocator of money and yields even better returns to investors?
Prof Ng: At the country level the government can do that through the accounting standards that are being followed in the country. This is very important to ensure that sufficient information about a firm is released to the investors in the market.
As professional academics, for research work we look at an index of a minimum 90 items on the accounting report to see what sort of information is being revealed by a firm to the public for it to be transparent. The timeliness and how prompt the firm is in releasing the information is very important. It is not voluntary but forced disclosure with a deadline under regulations that helps to have the information disseminated quickly to the public. In my opinion this, together with the internationally recognised accounting standards being followed, is sufficient disclosure of information for the investing public.
Ms Qian: Not only the quantity but the quality of the information is very important. Another aspect of the information being provided by a firm is how easy is it to interpret this information. Sometimes the financial statements being provided to the market cannot be understood by everybody. If the information can only be interpreted by the skilled investor then sometimes more information actually increases the information asymmetry.
That is why it is important to have the internationally recognised accounting standards so that the information can be widely understood by the market. And if a country's regulations help to generate enough information for the market and it is easy to access, this also helps to attract international investors to the country.
Prof Noe: Another way to produce information on these markets is to encourage the presence of investors who will help to produce the information for you. I am thinking of institutional investors. You may want a regulatory climate which is friendly for them, which allows them to cooperate with each other without too many restrictions on insider trading if they share information with each other.
In fact the regulations around large pension funds and other retirement systems can be designed in such a way to encourage institutional investors like them to invest in such a way that the markets become more transparent for the benefit of other investors.
Ms Qian: In closing our discussion, I think we should note that good information is easy to spread in the market and people can buy on it. But the bad information obviously travels slowly and is not that easy to trade on.
BT-NBS ROUNDTABLE
Panellists fron NTU's Nanyang Business School
Hwang Chuan Yang, Professor of Finance, and director of Research and PhD Programme
Thomas Noe, Visiting Professor of Finance and the Ernest Butten Professor of Management Studies at SaÃd Business School in Oxford University
Lilian Ng, Visiting Professor and the Hans Storr Professor of Finance at the University of Wisconsin in Milwaukee
Qian Xiaolin, Ph D researcher working on a finance dissertation on Information Risk
Moderator: Narendra Aggarwal, director, public affairs, Nanyang Business School
--------------------------------------------------------------------------------
OVERVIEW
STOCK markets around the world have rallied significantly in the first half of this year, erasing much of the losses suffered since last September's financial meltdown. For instance, the Singapore stock market saw a 38.7 per cent surge in its market capitalisation to $545 billion at end-June, a 10-month high since last August and shortly before the Lehman Brothers collapse sparked a stampede out of equities globally.
In an ongoing Nanyang Business School-Business Times Roundtable discussion series, senior professors and a research scholar at Nanyang Technological University's business school look into the issue of information risk and its impact on stock market investors and practitioners like stock analysts, portfolio managers, stock remisiers and dealers.
Narendra Aggarwal: As we start the discussion, how does the information flow on listed companies usually take place and get shared among the market players - both individuals and institutional investors - and the practitioners?
Lilian Ng: Primary information on listed companies depends on the general information environment of a country as well as that of a firm. Generally, it depends on how firms channel their information to the public, either through their earnings announcements or through various other company announcements from time to time.
The market also gets a lot of information through analysts following the firm. My research has shown that analysts following the firm have to really reveal a lot of information about the firm. For firms that have many analysts following them, generally very little private information is revealed in the trades of the stocks. This is because a lot of information about them is already known publicly. That helps in the sense that firms become more transparent, which is good for the market.
Thomas Noe: I would like to add that information also flows the other way as you get information from the markets going to the firms. Stock prices affect the firm's decisions. My research has shown that this leads to higher efficiency. If you have a liquid stock market and highly appropriate prices, firms operate better and choose better policies. So, the flow is bidirectional between the markets and the firms, rather than just the firms revealing information to the markets.
There are a huge number of analysts and traders both on the buy and sell sides, as also private investors who speculate in stocks, who gather their own information. For instance, if you have a consumer products company, it may have better information about its production technology, whereas the market may have a better understanding of the demand for its products. These people investigate and in making their stock picking decisions they affect the stock prices, thus sending signals back to the firm thereby helping it to make better decisions.
Hwang Chuan Yang: The firm learns the information from its stock price so that it can allocate the resources more efficiently and aim to run itself better. That is why it is important to create the environment so that all the correct information comes to the market as quickly as possible and gets reflected in the stock price.
In fact some people argue that even the information that insider traders might have comes to the market through their trading activity and soon the wider market is better informed about the firm.
Similarly, when a firm announces an investment decision and its stock price goes down, this means that the market thinks that the investment may not be such a good idea. On the other hand, if the price goes up, it is an indication that the firm may have some intangible assets which are being factored into its stock price. This reverse information flow from the market to the firm may in fact encourage the managers to issue more stock in view of the high price to raise more capital and go in for more net investment.
Qian Xiaolin: Actually the information is split into public and private information. The public information is available to everyone in the market which can be through the firm's public disclosure or through informed traders as their trading actions makes the information available to all.
Private information can come from insider information and also from skilled investors like financial analysts and portfolio managers who may have analysed the public information using their professional skills and interpreted it better compared to lay investors. And they can disclose that information to the market and make the price more informative. The skilled investors can also generate information from the whole industry and the broader economic environment of the country and thus help the manager to make better decisions in the investment or the financial policies of the firm.
Mr Aggarwal: Companies sometimes try to hide unfavourable news about their activities and performance. How does the market keep itself well informed and try to get as much news as quickly as possible?
Prof Ng: There are two ways for firms to disclose information - voluntary and regulatory. Firms often release information for investors to know about their firm so that they have more faith in them or when they may want to raise equity.
Firms also make regulatory disclosures on a periodic basis as may be required by law. Studies have shown that firms that make more reporting of financial information find that helps to reduce the cost of capital. It is important for a firm to know that the more information the public has about the firm, not only does that help to reduce the cost of capital (i.e., the financing cost) but it also raises the value of the firm.
My research has shown that analyst coverage helps reduce the amount of private information pertaining to a firm and also helps increase the efficient allocation of the firm's resources by having analysts reveal more information about the firm, compared to a firm with no analyst coverage. This is a critical component of having more information transmitted to the public.
Firms with no analyst following are typically more opaque. They tend to have problems in terms of raising money. Their accounting information is generally perceived to be less credible by the public, and this will affect their cost of capital, making it higher compared to that of firms with wider analyst coverage.
Prof Noe: Another benefit from analysts' following a company is that it increases interest in the stock, which increases the amount of uninformed trading by people who do not have information in the company. This is very useful as you need to have uninformed traders for informed people to make any money in the market. This increases liquidity of the stock in the market. Singapore firms that do not have analysts following them need to do something about it to get analysts to follow them on a regular ongoing basis.
Ms Qian: Besides having analysts' following, firms can also make themselves more available when there is increased institutional holding because the average investor may look at whether institutions are investing in them or not. Because the institutional investors are more skilled, they may have had their own analysts look into the firm's financial data, so the other investors can take a free ride. I would like to suggest that when institutions invest in a firm, it should take advantage of that by releasing the information to the investing public to create more interest in its stock.
Prof Noe: I am not sure if this happens in Singapore, but it does take place elsewhere. For instance when Warren Buffet buys a stake in a firm, it gets trumpeted. When he invested in an Israeli steel company a few years ago, the company released the information and it was front page news. It was Mr Buffet's first investment outside the United States and the Israeli company used it to its advantage by disclosing it. This created interest in the firm among other investors in the market and boosted its value.
Prof Ng: I think the same happens when Temasek or GIC invests in a firm at home or abroad. A lot of people get interested in those firms just by reading in the newspapers that these big funds have invested in them. I know that individual investors including laymen get interested in firms whose stocks are held by Temasek. This is because Temasek is considered a sophisticated and sound investor, and the individual investors would want to ride on information they think it has.
Prof Hwang: Actually more information disclosure by the firm and the analysts helps the investor to have a more level field in the sense that any adverse information about the firm gets known to all in the market and gets factored into the stock price.
In the United States, under Federal disclosure laws, a company cannot engage in selective disclosure of advance information to analysts or certain types of investors as used to happen in the past. Under the SEC's rules, now all information has to be released publicly by a listed company simultaneously to all in the broader market.
Ms Qian: The affect of this law is very interesting. While for the larger firms it reduces the information gap and the cost of capital, for smaller firms sometimes the cost of public disclosure can be quite high and this could discourage them from releasing information. Thus with the route of selective disclosure to analysts closed for smaller firms, they do not replace it with public disclosure due to the cost factor. The result is that there is less information available about the firm to investors in the market and the stock price may become less liquid as a result of the uninformed investors moving out of the market.
Mr Aggarwal: How can companies reduce the negative impact of adverse news on their share price? What suggestions would you like to make for firms to better manage the information risk from unfavourable developments on their stock trading?
Prof Ng: Sometimes companies wait till the last day of the trading week or even the close of trading for the week to make announcements, so that investors have the whole weekend to absorb the news and do not over react and engage in panic selling. This results in what some people call the Weekend affect. When trading resumes on Monday, the impact on the share price will not be as big as it would have been if the news had been released during the trading week.
To manage the likely impact from bad news, in the United States firms often drag their filings to the end of the earnings season and ask for extension of the results filing date to prepare the market for the announcement.
Prof Hwang: At this point I would like to highlight the risk from unsubstantiated rumours about the firm or, say, the health of its CEO or senior management that sometimes enter the marketplace. Given that information - be it good or bad - impacts the stock price, the firm should try to release as much information as possible to the market instead of the market having to react to speculation or unfounded rumours.
Generally, I would advise companies to have a strong public relations team to get as much information as possible to the market and be more transparent as opposed to being opaque. The bottomline is that creating a more level playing field for all investors through more information is better for the market and the stock price of the firm.
Ms Qian: Actually more information helps the investors to be more confident about the company. Even in bad times if the firm does not disclose enough information about itself, this can cause panic among investors as they can somehow sense that things are not going well for the company and this may result in more panic in the whole market.
The danger is that if a firm facing problems does not disclose what is happening and, say, some institutional investors sell the stock for whatever reason, including stock balancing, uninformed traders watching the informed traders' behaviour, might follow those traders and suddenly start selling and that could cause a price crash which would be bad for the company. Sometimes it may even cause the whole market to crash if the situation is bad.
Prof Noe: In managing information flows to the market, there is a downside to too strict enforcement of rules. For instance, if the manager of a firm is making a forecast of earnings and if he thinks he has some legal liability if he makes a mistake, he may decide not to make a forecast at all. Or he may end up giving a wide range so as to cover himself against any future liability which in a way defeats the very purpose of the forecast serving as a guide to the market.
Mr Aggarwal: What steps can be taken to reduce the information risk so that stock trading is encouraged and the market becomes an even better allocator of money and yields even better returns to investors?
Prof Ng: At the country level the government can do that through the accounting standards that are being followed in the country. This is very important to ensure that sufficient information about a firm is released to the investors in the market.
As professional academics, for research work we look at an index of a minimum 90 items on the accounting report to see what sort of information is being revealed by a firm to the public for it to be transparent. The timeliness and how prompt the firm is in releasing the information is very important. It is not voluntary but forced disclosure with a deadline under regulations that helps to have the information disseminated quickly to the public. In my opinion this, together with the internationally recognised accounting standards being followed, is sufficient disclosure of information for the investing public.
Ms Qian: Not only the quantity but the quality of the information is very important. Another aspect of the information being provided by a firm is how easy is it to interpret this information. Sometimes the financial statements being provided to the market cannot be understood by everybody. If the information can only be interpreted by the skilled investor then sometimes more information actually increases the information asymmetry.
That is why it is important to have the internationally recognised accounting standards so that the information can be widely understood by the market. And if a country's regulations help to generate enough information for the market and it is easy to access, this also helps to attract international investors to the country.
Prof Noe: Another way to produce information on these markets is to encourage the presence of investors who will help to produce the information for you. I am thinking of institutional investors. You may want a regulatory climate which is friendly for them, which allows them to cooperate with each other without too many restrictions on insider trading if they share information with each other.
In fact the regulations around large pension funds and other retirement systems can be designed in such a way to encourage institutional investors like them to invest in such a way that the markets become more transparent for the benefit of other investors.
Ms Qian: In closing our discussion, I think we should note that good information is easy to spread in the market and people can buy on it. But the bad information obviously travels slowly and is not that easy to trade on.
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