Prospective information in managements' discussion and analysis: a test of incremental information content

The Securities and Exchange Commission (SEC) requirement that prospective information be disclosed in Managements’ Discussion and Analysis (MD&A) assumes that such information is useful to annual report users. This article tests that assumption, and also investigates whether the usefulness of prospective information increased after the SEC issued an interpretive release (Financial Reporting Release, FRR-36) encouraging fuller disclosure. Cumulative abnormal returns were regressed on a disclosure index (a measure of usefulness) developed from a survey of Chartered Financial Analysts. Change in cash flows, size, exchange, and unexpected earnings were controlled. The significant association found between abnormal security returns and the disclosure index suggests that disclosures of prospective information in MD&A are useful. Change in cash flows was significant in one model, suggesting that the prospective disclosures have incremental information content over change in cash flows. Also, the stronger association in the time period after FRR-36 suggests that it had its intended effect of improving the usefulness of prospective information in MD&A. Other studies have noted the increase in number of disclosures as a result of FRR-36. However, this study is the first to document that the disclosures are useful.