It's well known that COVID-19 provided an unanticipated shock to the economy as a consequence of what economist Paul Krugman termed the "economic equivalent of a medically induced coma." As a result, many companies were compelled to disclose historic performance that was, to put it mildly, at odds with their expectations of a few months prior, with little insight about the shape of future performance. In this paper, The Spread of COVID-19 Disclosure, from the Corporate Governance Research Initiative at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stanford University, the authors looked at how companies responded to this situation, examining the levels of transparency that companies provided in the "widely uncertain" setting of COVID-19.
In their study, the authors reviewed periodic and current reports for 3,644 public companies in the period between January 1 and May 29, 2020, searching for references to COVID-19—including references to face mask, hand sanitizer, social distancing and hand washing. The first references in the second half of January were decidedly mixed: a company touting its progress on a vaccine and another company describing its need to close significant operations in China. The authors found that there were few references in the early months of the year; by January 31, only 0.7% of companies referred to the coronavirus, with the percentage reaching only 22% by the end of February. But, as the economy began to shut down across the country and in Europe, "disclosure increased exponentially: 41 percent by March 15, 64 percent March 31, 73 percent by April 15, and 86 percent by April 30. By [May 29], virtually every company (99.6 percent) made some level of disclosure about the pandemic." In periodic reports, disclosure was most frequently found in risk factors, MD&A and financials, and less frequently found in the general business description.
The study also examined disclosure by industry, finding considerable variation even among competitors. Not surprisingly, by March 31, 100% of companies in the travel and airlines industries referred to COVID-19, and companies in the entertainment industry were close behind at 91%. However, "[p]erhaps unexpected, the financial services industry, which has incurred significant losses, had relatively low levels of disclosure rates in March (55 percent). The utilities industry had the lowest disclosure rate (39 percent)."
Throughout the period, the most common reference to COVID-19 was in the litany of risks recited in the forward-looking statements disclaimer (59%). (Only 59%?) After that, the impact of COVID-19 was discussed with respect to cash (47%), sales (44%), supply chain and debt (each 40%). As COVID-19 progressed geographically from China, affecting more of the United States, the substance of disclosure also varied,
"as companies came to different realizations about how the virus would impact their business. In the early months, supply-chain impacts were the most common issue disclosed; by May, disclaimers to forward-looking statements became the most commonly issued disclosure, as companies realized that the full effects of the pandemic could not be easily quantified. Also, we see a significant increase in disclosure on cash positions, as market fears about liquidity and solvency increased. Cash was the seventh most frequently disclosed issue in February; by May, it rose to second....Related to this, disclosure varied based on a company's exposure to China. Companies that derive more than 10 percent of their revenue from China were sooner to disclose coronavirus impacts. By May, companies with lower exposure to China increased their disclosure volume."
SideBar
How much influence did the SEC have on disclosure? While that's not addressed (and may be unknowable), it is notable that, as early as February 3, SEC Chair Jay Clayton indicated in a statement (regarding an unrelated rulemaking) that he had "asked the staff to monitor and, to the extent necessary or appropriate, provide guidance and other assistance to issuers and other market participants regarding disclosures related to the current and potential effects of the coronavirus." Although he recognized that the impact might be uncertain and difficult to predict, "how issuers plan for that uncertainty and how they choose to respond to events as they unfold can nevertheless be material to an investment decision." (See this PubCo post.) A statement focused primarily on the impact of the virus on financial disclosures and audit quality was issued in mid-February (see this PubCo post), with more expansive statements on disclosures regarding COVID-19 in April. For example, in April, Clayton and Corp Fin Director Bill Hinman urged companies, as they issued earnings releases and conduct analyst and investor calls, to provide as much information as practicable, focusing their disclosure less on historical information and more on "current financial and operating status, as well as future operational and financial planning" under "various COVID-19-related mitigation conditions." Among other topics, they encouraged companies to address liquidity and resource needs, receipt of financial assistance under government programs, company efforts to protect worker health and customer safety and strategies to incrementally resume regular operations as the crisis resolves. (See this PubCo post and this PubCo post.)
COVID-19 was also the subject of Corp Fin Disclosure Guidance 9 issued in March and 9A in June. For example, in the March guidance, the staff recognized that the uncertainties associated with COVID-19 made its effect on specific companies difficult to predict and, in many circumstances, the impact was beyond a company's control and knowledge. Still, "the effects COVID-19 has had on a company, what management expects its future impact will be, how management is responding to evolving events, and how it is planning for COVID-19-related uncertainties can be material to investment and voting decisions." They observed that disclosure of COVID-19 risks and effects may be required or appropriate in MD&A, the business section, risk factors, legal proceedings, disclosure controls and procedures, internal control over financial reporting, and the financial statements or other sections, whether or not in response to a specific line item requirement. (See this PubCo post and this PubCo post.) In addition, the staff made its views known to individual companies through the comment process.
The study also looked at correlations between disclosure and negative stock price performance, finding that, although "most companies experienced sharp share price declines in March, companies that issued COVID-19-related disclosure in March experienced 30-day stock price declines that were significantly more negative than companies that did not disclose in March (-22.5 percent versus -12.5 percent)." Industry-adjusted, those percentages change to a 5.9% decline for companies that disclosed COVID-19 impact in March compared to a 2% increase for companies that made no disclosure. The authors conclude that the "data suggests companies that performed worse were more likely to disclose the virus' impact, potentially because of greater exposure and risks."
The authors also drilled down to look at variation within specific industries, highlighting, for example, wide differences within industries in terms of the level and nature of disclosure. Why were some companies silent about the impact of the virus in their SEC filings, the authors ask, even though they experienced a decline in stock price and even though their competitors made multiple references? Can this "black swan" event, the authors ask, provide boards with "insights to prepare for other possible outlier events, such as climate events, terrorism, cyber-attacks, pandemics, and other emergencies? Should these insights be disclosed to shareholders?"
Originally published 30 June, 2020
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