The semi-strong form efficiency is mainly concerned with the speed and accuracy of the market in incorporating new public announcements about a firm in its share prices such that no abnormal returns are attributed to the information. In this state of the market, neither can technical analysis nor fundamental analysis be used to outperform the market (Fama 1970). It is under this form of efficiency that the publication of information in interim reports is expected not to influence share price abnormal returns. Opong (1995) argued that if the market is efficient, the publication of interim reports would result in a share price return equal to zero. With relation to this study, semi-strong efficiency would lead to two deductions.
Firstly, both complementary and supplementary narrative commentaries would have an abnormal share price returns equal to zero. Secondly, because of the same share price return, there would be no difference in the return attributed to investors‟ use of either complementary or supplementary narrative commentaries.
Healy and Palepu (2001) discussed the role of disclosures in the capital markets using the agency concept and information asymmetry. They argued that agency arises when savers invest in a business venture in which they relegate role of utilising the funds to management.
However, the management at times makes self-interested decisions that expropriate investors‟
funds through high executive pay packages and other decisions that devalue the investors‟
equity. Top reduce these instances, Healy and Palepu (2001) suggest that one alternative is the signing of optimal contracts between the two parties. Such contracts require management to reduce information asymmetry by providing information on the firm‟s performance so that
151
the investors can assess the management‟s performance. Alternatively, the shareholders may use corporate governance mechanisms such as board of directors who have the role to monitor and discipline management on behalf of investors. Similarly, for this role to be executed, the management has a responsibility to reduce information asymmetry by reporting on its performance to the board of directors. The other option for reducing the agency problem is that investors may use services of information intermediaries, such as financial analysts and rating agencies who engage in private production of information to uncover any misuse of funds by management (Healy and Palepu 2001). This may at times be enhanced through regulation. To protect their positions, management will influence their appraisals through reducing information asymmetry by providing disclosures that reduces instances that may lead to wrong judgements.
In all the solutions that Healy and Palepu (2001) provide, which are based on a review of prior empirical and theoretical work, the key element is that disclosures, such as complementary and supplementary narratives in interim reports, help to reduce information asymmetry between investors and management. This is either directly by the two parties engaging with each other through optimal contracts or use of proxies, such as boards of directors and financial intermediaries. Even in a semi-strong efficient market, Watts and Zimmerman (1978; 1986) argued that management might prefer to provide accounting disclosures to reduce information asymmetry and agency costs, as there are significant costs in writing and enforcing contracts as well as political costs in regulatory processes. Emphasising this, studies (e.g. Barry and Brown 1985; Healy and Palepu 2001) consider that managers who engage in capital market transactions have an incentive to provide disclosures, such as complementary and supplementary narratives to reduce the information asymmetry problem and associated cost of capital.
The earliest empirical work on semi-strong efficiency is documented by Fama, et al (1969), examining the impact of information implied by stock splits on share prices in the US. The results showed that the information was spontaneously incorporated in share prices on its release such that there were no abnormal returns accrued to the announcement. Among early tests of semi-strong efficiency in the UK is Franks et al (1977) in which information about
152
mergers was predicted three months to the event. This indicated presence of semi-strong efficiency because abnormal returns did not accrue to the publication of information about the merger due to the anticipation of the news. In addition, the possibility of any miniature returns was ruled out, as they would be absorbed in transaction costs. In a related study, Firth (1976) established presence of abnormal share price movements prior to announcement of take-over bids. The tendency was ascribed to information leakage rather than prediction, thereby associating the market with inefficiency. The magnitude of occurrences being limited to a few firms obliterated the thesis that the market is inefficient.
Contrary to the studies above, another line of literature (e.g. Ball 1978; Bernard and Thomas 1989) observe post-announcement drifts in share prices after a new piece of information is published. Ball (1978) envisaged that either such drifts are a result of the researcher‟s misspecification of the market equilibrium by omission of a component in computational model or a failure of market efficiency in incorporating new information into share prices.
The failure to include new published disclosures into share prices was conjectured as a result of either the high cost of using the new information or information-processing frictions that deter the market‟s ability to capsulate the predictive potential of the news. Ball (1978) was inclined to suggest that market inefficiency was more likely to be the cause of the post-announcement drifts. Bernard and Thomas (1989) found it hard to suggest the cause of the drifts and assumed that the market does not understand the autocorrelation between quarterly returns. Fama (1991) discard the presence of post-announcement drifts as evidence of semi-strong form market inefficiency by suggesting that the drifts could be a result of misspecification in measuring abnormal returns. Also, in response to Bernard and Thomas (1989), size could have been the explaining factor since small firms are susceptible to unrelated price movements. Fama (1991) disagreed with the direct attack on market efficiency that participants do not understand earnings movements. He rather argued that analysts closely follow share price movements such that drifts cannot simply indicate inability to understanding movements.
153