Disclosure Dynamics along the Supply Chain

(ProQuest: . denotes formulae omitted.)INTRODUCTIONA growing stream of research investigates intra-firm disclosure dynamics (e.g., Dye & Sridhar, 1995; Sletten, 2012; Tse & Tucker, 2010). However, these studies primarily focus on how a firm's voluntary disclosure can be affected by other firms within the same industry. This paper examines the disclosure dynamics of firms in a supply chain relationship. We study the impact of major customers' voluntary disclosures on the subsequent disclosure decisions of their suppliers. We also investigate the relation between suppliers' subsequent disclosure decisions and their future stock market performance.Theoretical studies suggest that a firm's value-maximizing voluntary disclosure decision can be influenced by the disclosures of other firms (Dye & Sridhar, 1995; Acharya, DeMarzo & Kremer, 2011). Dye and Sridhar (1995) analyze the disclosure decisions of firms in the same industry when there is a positive correlation in the timing of the receipt of information by intraindustry firms. In Dye and Sridhar (1995), investors revise upward their beliefs of a firm's receipt of information if they observe the disclosures of other intra-industry firms. With the fear of being considered as the firm with the worst possible news, firms with news that is above the disclosure threshold (news that are better than the worst) disclose their information following the disclosures of other firms in the industry. Assuming that firms receive positively correlated news content, Acharya, DeMarzo and Kremer (2011) show that when bad news from related firms lowers investors' estimate of a firm's value, disclosure threshold drops and previously withheld bad news are disclosed. However, good news from related firms leads investors to revise upwards a firm's value, which increases the disclosure threshold and thus reduces a firms' propensity to disclose.The unique features of a supply chain relationship make it an interesting test ground to investigate the disclosure dynamics of related firms. Suppliers and customers have a strong positive correlation between their cash flows because of their business tie (Cohen & Frazzini, 2008). The close link of supplier and customer cash flows suggests that the timing and the content of information received by suppliers and customers are likely to be positively correlated. This strong positive correlation satisfies the assumptions of disclosure dynamics models (Dye & Sridhar, 1995; Acharya et al., 2011) and makes the supply chain relationship an ideal setting to test predictions of theories. In contrast, the timing and content of information received by firms within the same industries can be positively or negatively related depending on whether the information is about the overall industry or just pertains to competition among a few intra-industry firms (Kim, Lacina & Park, 2008; Pandit, Wasley & Zach, 2011). This ambiguous correlation of information can potentially weaken the power of tests using the intra-industry setting.We study the impact of major customers' disclosure on their suppliers' disclosure decisions. Previous literature shows that suppliers are usually smaller than their major customers and receive a substantial portion of their sales from their major customers (Cohen & Frazzini, 2008; Pandit et al., 2011). These findings suggest that major customers have a greater impact on the business of suppliers than vice versa. Thus, investors can reliably infer the timing and content of information received by suppliers and revise their beliefs of the suppliers' value based on the disclosures of their major customers. Based on the predictions of Dye and Sridhar (1995) and Acharya et al. (2011), we expect that disclosures from major customers can significantly impact suppliers' disclosure decisions.Our primary measure of voluntary disclosure is management earnings forecasts (MEFs). We use MEFs because these disclosures can greatly influence investors' belief of firm value (Beyer, Cohen, Lys & Walther, 2010; Ball & Shivakumar, 2008). …