North-Holland
The study investigates the information content of the foreign sensitive payment disclosures made
during the Securities and Exchange Commission's 'voluntary' disclosure program. The results of
the information content tests and the tests of the relationship between payment size and abnormal
security returns imply that investors may have been reacting to the expectation of the loss of future
business or to the possibility of future government sanctions.
I. Introduction
Investigations initiated as a result of the Watergate scandal disclosed that
various corporations had made payments to foreign government officials for
the purpose of obtaining or retaining business. Since several of these publicly
held corporations did not disclose the payments in their accounting records,
the Securities and Exchange Commission (SEC) undertook an investigation to
determine the extensiveness of the activities. 1 The investigation included a
program of voluntary disclosure of past payments with an offer of immunity
from prosecution under the provisions of the Securities Acts relating to the
filing of fraudulently reported information. The Wall Street Journal issue of
June 23, 1978 reported that U.S. corporations disclosed questionable payments
under this program amounting to more than 300 million dollars.
The SEC voluntary disclosure program in some cases stirred considerable
controversy. Participating firms questioned the fairness of being forced to
disclose, and to refrain from making sensitive payments which they believed to
be a normal business practice. In addition they complained about the threat of
government sanctions aimed at ensuring that the payments did not continue.
For example, Lockheed claimed that 'disclosing payoff terms' could imperil
present and future contracts [Wall Street Journal (WSJ): July 30, 1975]. In
* We appreciate the comments made by Phil Shane, Ross Watts and Jerry Zimmerman on earlier
versions of this paper.
**Present address: Arizona State University, Tempe, AZ 85287, USA.
~The SEC authorized this investigation on the basis of its responsibility for assuring full and
adequate disclosure of financial information.
addition, Lockheed said it would resist SEC efforts to block it from 'paying
bribes abroad' since such payments were necessary to obtain sales [WSJ:
August 6, 1975]. It was only when the government threatened to remove loan
guarantees that Lockheed finally agreed to stop making the payments [WSJ:
August 26, 1975].
The purpose of this paper is to examine how common stock investors
interpreted 'economic signals' associated with disclosed sensitive payments
under the SEC voluntary program. Our major results are: (i) a negative market
reaction is associated with the disclosure of sensitive payments that were made
to secure or retain business, and (ii) the decline in market value of the equity
varies with the absolute size of the payment. These findings support the theory
that the negative reaction at the time of the disclosures may be related to the
possibility of future government sanctions or to the expectation of the loss of
future business.
The results are also consistent with the SEC's position on sensitive payments
which was later accepted by Congress in framing The Foreign Corrupt
Practices Act (FCPA) of 1977. 2 The SEC's position was stated at a number of
forums including one on June 27, 1975, where SEC Chairman Garrett gave a
speech on the subject. In his speech Garrett contended that a payment which
might be quite small in relative terms to a large corporation, might have
important foreign policy implications as well as implications for evaluating
management integrity. Also it is reasonable to assume that this government
policy should have been widely known around the time payments were being
disclosed by the firms in our sample.
In the next section we briefly discuss the theoretical background for the
information content of the sensitive payments. This is followed by empirical
sections where we present the statistical tests and results supporting our
findings. In the final section on conclusions we discuss some of the implica-
tions of a negative market reaction to sensitive payments.
2 The SEC's position is found in The Hearings before the Subcommittee on International Economic
Policy (p. 60).
D.B. Smith et al., Foreign sensitive payment disclosures 155
The second hypothesis deals with the explanation for the information
content of the sensitive payment information. Specifically, we theorize that
investors are reacting to (1) the expectation that the firms will lose sales in the
future due to their inability to make sensitive payments or (2) the expectation
that firms disclosing payments might be subject to future government sanc-
tions. We suggest that the loss is a function of the absolute size of payment for
both of these explanations of the information content, so:
H2: Larger absolute payments are associated with greater declines in market
values.
3. Empirical tests
3The hearing concerned the confirmation of the former president of Textron as Secretary of the
Treasury. During the hearing it was disclosed that Bell Helicopter which is a subsidiary of Textron
had made a 2.9 million dollar sensitive payment abroad.
156 D.B. Smith et al., Foreign sensitive payment disclosures
u,t* =
(1)
where ;~(U,.), the standard deviation of the ith firm's residual, is estimated by
1 2
250 E U/j .
j = -290
4During our specification of the sensitive payment dates we noted only five cases where more
than one sensitive payment was disclosed on the same day. In four cases two payments were
disclosed and in one three payments were disclosed on the same day. In addition, six pairs of
payments occurred on contiguous trading days. The number of overlapping payment disclosures is
so small that the independence assumptions among residuals used in the empirical tests is assumed
to be valid.
D.B. Smith et al., Foreignsensitivepayment disclosures 157
where St* was the calculated cross-sectional standard deviation for the sample
of CAR's. A value of U~A less than - 1 . 6 4 supports the first hypothesis.
3.3. Statistical test of the association between the size of sensitive payment
disclosures and change in firm value
The second set of tests examines the relationship between the sensitive
payment disclosure for each firm i and the change in firm value. 5 The
relationship can be derived theoretically from the following equation of the
realized rate of return for the period t (r,):
V~t is the value of the firm (all equity) at the end of the period of disclosure
(period t) if the sensitive payment had not been disclosed, and V~t_~ is the
value at the end of day t - 1. Li is the loss in market value suffered by the firm
as the result of the disclosure of the sensitive payment. The expected rate of
return on the firm (r~) is defined as
r, - ri ~ - Li/Vit_ 1. (7)
The relationship between Lg and the disclosure of the sensitive payment (,Pi)
follows from the position of the SEC which implied that possible future
5We wish to thank Professor Watts for providing us with the derivation of the effect of the
payment disclosure.
6Given the small number of overlapping payment dates described in footnote 4, we assumed
independence among sample observations.
158 D.B. Smith et aL, Foreign sensitioe payment disclosures
Table 1
Characteristics of standardized cumulative average residuals ( C A R ) calculated to include day
prior to and day of the sensitive payment announcement.
Wilcoxon
Number of Standard sign-rank
Average Median observations deviation t-value test value
government sanctions against firm i would be a function of the size of Pi, i.e.,
let L = b P i where b > 0. Thus we have
u, = ,, + x) +
7The t-tests we used are robust for departures from normality [Box and Anderson (1955)].
However, outliers could bias our results so we examined the distributions of the cumulative
average residuals for evidence that the normal assumption might be incorrect. This involved the
use of a measure that was essentially equivalent to the Shapiro-Wilk test. The test was based on
the correlation coefficient relating the cumulative average residuals to their estimated normal
scores. The correlation coefficient of 0.98 indicated that the distributional assumption necessary for
the parametric test appears to be appropriate.
D.B. Smith et al., Foreign sensitive payment disclosures 159
Table 2
Cross-sectional regression results; U~-- a + b(Payment/Common equitya).
a b Adj. R2 F
Coefficient - 0.0018 - 0.6675 19.5% 27.16
Std. deviation 0.0027 0.1344
t-value - 0.8400 - 4.9665
The t-value corresponding to the Wilcoxon statistic was - 1.30 which allows us
to reject the null hypothesis of no information content at the 0.10 level.
Our second set of tests allowed us to assess the null hypothesis of no
association between payment size and abnormal security return. Our regression
analysis results are found in table 2.
Notice that b is negative as expected and significant beyond the 0.01 level.
In addition, a is not significantly different from zero. These results permit
rejection of the null hypothesis that no association existed between payment
size and market reaction and hence are supportive of our second alternative
hypothesis.
As an additional check of our results we calculated a Spearman correlation
coefficient for the unstandardized C A R and the payment divided by net assets.
The correlation coefficient is in the anticipated direction ( r s -- - 0.225) and it is
significant beyond the 0.02 level. Thus, the result provides support for a
monotonic relationship between the payment size and changes in common
stock returns and so supports the parametric results which indicated a linear
relationship between payment size and changes in common stock returns. 8
5. Conclusion
The Watergate investigators disclosed that firms had not only made illegal
contributions to .President Nixon's campaign but had. also made sensitive
payments to foreign government officials. The SEC carried out a program of
voluntary disclosure which encouraged firms to disclose any foreign sensitive
payments. An investigation of the information content of these foreign sensi-
tive payment disclosures implied that investors found the size of these pay-
ments to be associated, with their information content. These results are
consistent with the hypothesis that investors were reacting to expected future
government sanctions or loss of future business that was dependent on the
firm's ability to make sensitive payments.
8We repeated all of the tests using net assets as a surrogate for market value and our results were
not significantlydifferent from the ones presented here.
160 D.B. Smith et al., Foreign sensitwe payment disclosures
Payment
to value of
common equity
44 days prior
to sensitive Standardized
Payment in payment cumulative average
Firm name millions disclosure two-day return
A.M.F., Inc. 1.400 0.003189 -0.75165
Abbott Labs. 0.500 0.000447 - 1.83423
Aluminum Co. Amer. 0.025 0.000015 -1.50755
American Cyanamid Co. 1.200 0.000918 -0.33375
American Home Prods. Corp. 3.400 0.000664 0.07849
Anderson Clayton & Co. 2.100 0.008918 -0.64771
Apeco Corp. 0.216 0.010660 0.02546
Asamera Inc. 1.900 0.022784 -0.03394
Ashland Oil, Inc. 1.000 0.002462 0.08202
Baxter Travenol Labs. Inc. 2.100 0.001561 -0.67882
Beker Inds. Corp. 0.241 0.002384 0.24183
Belco Pete Corp. 2.000 0.014119 - 1.59665
Black & Decker Mfg. Co. 0.105 0.000168 0.61235
Brunswick Corp. 0.020 0.000071 -1.46583
Burndy Corp. 0.155 0.001334 0.26375
Buttes Gas & Oil Co. 0.075 0.000900 -0.42851
C.P.C. Intl. Inc. 0.150 0.000140 -0.22415
C.R.S. Group Inc. 1.300 0.110794 0.36770
C.T.S. Corp. 0.175 0.002260 -0.03536
Carnation Co. 1.261 0.000958 -0.11738
Carrier Corp. 2.200 0.008121 -0.71559
Carter Wallace Inc. 0.610 0.011307 0.55154
Castle & Cooke Inc. 0.008 0.000033 1.85206
Central Soya Inc. 9.000 0.043488 -0.01980
Champion Intl. Corp. 0.456 0.000404 -0.18668
Chromalloy Amern. Corp. Del. 0.067 0.000385 -1.06066
Chrysler Corp. 2.500 0.002338 0.27719
Cincinnati Milacron Inc. 3.900 0.029598 -0.23122
City Investing Co. 0.600 0.000397 0.27931
Clark Equip. Co. 0.095 0.000162 0.60387
Coca Cola Co. 0.300 0.000058 0.24183
Colgate Palmolive Co. 0.315 0.000151 0.10536
Combustion Engr. Inc. 0.570 0.001216 0.24254
Consolidated Foods Corp. 0.015 0.000026 -0.26799
D.B. Smith et al., Foreign sensitive payment disclosures 161
References
Brown, S. and J.W. Warner, 1980, Measuring security price performance, Journal of Financial
Economics 8, 205-285.
Box, G.E. and S.L. Anderson, 1955, Permutation theory in the derivation of robust criteria and the
study of departures from assumptions, Journal of the Royal Statistical Society Series B 17,
1-12.
Committee on International Relations House of Representatives, 1975, The activities of American
multinational corporations abroad (U.S. Government Printing Office, Washington, DC) 57-62.
Dann, L.Y., 1981, Common stock repurchases: An analysis of returns to bondholders and
stockholders, Journal of Financial Economies 9, 113-138.
Hogg, R. and A. Craig, Introduction to mathematical statistics (Macmillan, New York) 314-316.
Hong, H., R. Kaplan and G. Mandelker, 1978, Pooling vs. purchase: The effects of accounting
mergers and stock prices, The Accounting Review 68, 31-47.
Penman, S., 1980, An empirical investigation of the voluntary disclosure of corporate, earnings
forecasts, Journal of Accounting Research 18, 132-159.
Ryan, T., 1981, Minitab reference manual (Duxbury Press, Boston, MA) 47-49.
The Wall Street Journal, 1975, Lockheed says disclosing payoff terms to foreigners could imperil
contracts (Dow Jones and Co., New York).
The Wall Street Journal, 1975, Lockheed says it will resist SEC efforts to block it from paying
bribes abroad (Dow Jones and Co., New York).
The Wall Street Journal, 1975, Backing for Lockhead loans threatened by U.S. if overseas bribes
aren't halted (Dow Jones and Co., New York).