For more information, Contact: Barbara Buell at (650) 723-3157
March 1998
Just over two years ago, Congress passed a controversial "safe harbor" law as part of the Private Securities Litigation Reform Act of 1995. The intent of the legislation was to reduce frivolous shareholder suits and encourage managers to disclose more information regarding their companies' future prospects. Critics believed it would license executives to stretch the truth with rosy profit projections in order to drive up stock prices.
What has happened since the law took effect? Have management forecasts of corporate performance become overblown and inaccurate? Two Stanford Business School faculty members Karen Nelson and Ron Kasznik, both assistant professors of accounting, find that the new law has had a positive effect. Their conclusions are based on a recently completed study of 547 computer, software and drug firms. Conducted with Marilyn Johnson, assistant professor of accounting at University of Michigan Business School, the research examines 1,178 earnings and sales forecasts issued by these firms during 1994 and 1996, the years immediately surrounding the Reform Act's passage.
Although the Securities and Exchange Commission reported last year that the new law had little effect on corporate disclosure, Kasznik and Nelson's new study finds otherwise. "We discovered that there was a significant post-Act increase in both the frequency of firms issuing forecasts and the average number of forecasts firms issued," says Nelson. The increase in forward looking disclosures is primarily attributable to managers issuing more long horizon forecasts of good news and short horizon forecasts of bad news.
There is also evidence that managers provided more detailed forecasts after the safe harbor law passed, particularly the computer and software firms. The researchers believe that managers were less hesitant to disclose certain details, such as narrower ranges of expected future earnings and sales, because of the protection afforded by the safe harbor law.
"We also looked at what actually happened compared to what managers said would happen," says Nelson. They find that the increase in disclosure was not accompanied by a deterioration in the quality of the information released. Despite critics fears, forecasts issued after enactment of the safe harbor are no more optimistically biased than those issued previously. "Investors have been clamoring for more forward-looking information," says Nelson, "It appears that with the new safe harbor companies are responding."
Barbara Buell
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