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Journal of Accounting and Economics 6 (1984) 153-162.




David B. SMITH,** Howard STETTLER and William BEEDLES

University of Kansas, Lawrence, KS 66045, USA

Received December 1982, final version received February 1984

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.

0165-4101/84/$3.00 1984, Elsevier Science Publishers B.V. (North-Holland)

154 D.B. Smith et al., Foreign sensitive payment disclosures

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. Theoretical background of information content tests

One troublesome feature with the voluntary SEC program was that firms
disclosed payments regardless of how they were used in obtaining sales. Firms
in some cases disclosed payments which were made in order to influence minor
government officials to carry out duties they should have done without
payment. These so called 'grease' payments were not forbidden by the FCPA
to firms engaged in foreign business if they were a normal business practice.
Also, the size of the disclosed payment might be a surrogate for the severity of
the effect of future government actions since small payments might be per-

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

mitted grease payments, while large payments were likely to be forbidden

payments made to influence foreign officials with discretionary authority.
Based on this background two hypotheses are tested.

Hi: The payment disclosure is associated with a decrease in firm value.

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

The next section contains a description of tests of these hypotheses.

3. Empirical tests

3.1. Sample selection and announcement date

Our sample is taken from a list of companies disclosing sensitive corporate
payments as of April 1, 1978 that was compiled by the Washington Service
Bureau Inc. The 133 firms included in our sample are those which use a Form
8K to initially disclose that they had made the payments.
Firms are eliminated from the sample if they did not conform to any of five
criteria. First, the payment had to be made to a foreign (non-U.S.) official
rather than a domestic official (four firms were eliminated). Second, the size of
the payment had to be disclosed in either a Form 8K or the WSJ (17 firms
were eliminated). Third, the return information for the period beginning 292
days prior to the announcement of the payment and ending 40 days after the
announcement had to be available from the University of Chicago's Center for
Research in Securities Prices data file (12 firms were eliminated). Finally, one
firm is eliminated because it announced unusually large losses concurrently
with the announcement of the payment and one firm is eliminated because the
initial disclosure of the sensitive payment came during a Senate Confirmation
Hearing) The remaining sample of 98 firms is listed in the appendix.

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

The sensitive payment disclosure date is isolated by reviewing the Wall

Street Journal Index and by reading the Form 8K filed with the SEC disclosing
the payments. The disclosure date used for the Form 8K is taken from the
date-received stamp on the first page of the Form 8K unless an earlier date is
indicated in the text. The earliest date indicated in the WSJ or Form 8K is
used in the study. 4

3.2. Statistical test of the sensitive payments" information content

Testing for the impact of the announcement of the sensitive payments
involved employing the mean adjusted residual analysis techniques discussed
in Brown and Warner (1980) and Dann (1981). The mean daily return for each
security over the period from 290 days to 41 days prior to the announcement
date (i.e., t = - 2 9 0 to t = - 4 1 ) is used as an estimate of the security's
expected return. The expected return is subtracted from the actual security
return in day t, and the resulting residual (U~t) is used to provide a measure of
the security's abnormal performance on that day. Following the procedures
described by Dann (1981), a normalized residual [U,.7] for period t is then
defined as

u,t* =
where ;~(U,.), the standard deviation of the ith firm's residual, is estimated by

1 2
250 E U/j .
j = -290

Because of the difficulty in exactly specifying the announcement date, and

the possibility that information about the sensitive payments became known
prior to the date we specified, the abnormal performance measure used in our
information content hypothesis test is a cumulative average residual (CAR).
The CAR is a firm-by-firm summation of the residuals for the period one day
prior to the announcement date and the announcement date (two days),

u,**= 1 u,.7, (2)

~- t 1
where U,.** is the CAR for firm i's common stock.

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

The test statistic is calculated according to Penman (1980),

UtA = ~, U~t** S t* / Trffq- ) , (3)


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,):

r,= (V,- V,_x- (4)

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

ri= ( E ( V ~ t ) - V~t-~)/V~t_~. (5)

Substituting eq. (5) into eq. (4) and rearranging yields the following expression
for the abnormal rate of return on the firm (rit - r):

l'it-- ri~- ( V i t - E ( V i t ) ) / V i t - 1 - Li/Vit_ 1. (6)

If the firms in the sample-make disclosures of the sensitive payments on

different calendar days, in an-efficient market we expect V/t -- E(V/t) ~ 0 SO that
eq. (6) becomes 6

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.
Number of Standard sign-rank
Average Median observations deviation t-value test value

- 0.1616 -0.0344 98 0.84 - 1.91 - 1.30

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

rit -- ri = - b P i / l~it_ x. (8)

Eq. (8) suggests a relationship between the unstandardized abnormal returns

rit - ri and the sensitive payment divided by the value of the firm at time t - 1
(V~t_I). The regression equation we use to test the hypothesis regarding the
relationship between the sensitive payment disclosure for each firm i and
abnormal returns is

u, = ,, + x) +

where a and b are estimated parameters, e, is a stochastic error term, Vt_ ~

equals the value of firm i's common equity 44 days prior to the sensitive
payment's disclosure, and U/= Et___~U~t. Ut. t is explained in section 3.2 and is
equal to the actual security return on day t minus the expected return
estimated over the period 290 to 41 days prior to the disclosure of the sensitive
payment information. If the loss is a function only of the size of the sensitive
payment, then a should equal zero and b should be negative.

4. Results: Information content of sensitive payment

The results of our hypothesis test of the sensitive payments information
content are found in table 1.7 Both the mean and median values are negative as
we predicted, and the null hypothesis of no information content can be
rejected at the 0.03 level with our one-tailed test (t = -1.91). In addition we
calculated the Wilcoxon statistic which is a distribution-free metric that takes
into account only the rank of the absolute value of each residual and its sign.

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

aMarket value of common equity 44 days prior to payment disclosure.

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
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

Appendix 1: Sample of finns disclosing foreign sensitive payments

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

Cook Utd. Inc. 0.006 0.000348 - 1.95374

Core Labs. Inc. 0.180 0.014898 -0.77004
Dart Inds. Inc. 0.016 0.0(K~22 -0.09405
Dresser Inds. Inc. 0.024 0.000024 0.09405
Eaton Corp. 0.113 0.000152 0.11597
Electronic Assoc. Inc. 0.083 0.007774 -0.03960
Emhart Corp. Va. 1.500 0.004753 -0.84287
Ex. Cell O. Corp. 3.000 0.014098 0.30052
Fairchild Camera & Instr. Corp. 0.225 0.001018 1.01470
Figgie Intl. Inc. 1.000 0.023244 -1.03733
Foster Wheeler Corp. 2.400 0.019550 -0.18455
General Foods Corp. 0.106 0.000077 0.75519
General Tel. & Electrs. Corp. 2.200 0.000717 0.71276
Goodrich B. F. Co. 0.124 0.000337 -0.17466
Gulf & Westn. Inds. Inc. 0.400 0.000414 0.16829
Gulf Oil Corp. 4.200 0.001052 0.83721
Hercules Inc. 0.666 0.000468 -0.66539
Honeywell Inc. 1.800 0.002803 - 0.69155
Ideal Toy Corp. 0.020 0.000835 - 0.63145
Ingersoll Rand Co. 1.615 0.001170 - 0.84004
International Minerals & Chem. 3.000 0.004942 -0.72196
Johnson & Johnson 0.990 0.000186 2.12839
Joy Mfg. Co. 0.095 0.000173 -0.49497
Koppers Inc. 0.800 0.001671 -2.00535
Levi Strauss & Co. 0.075 0.000189 -0.14425
Libbey Owens Ford Co. 0.226 0.000564 -1.54503
Lockheed Corp. 22.000 0.140858 -2.90126
Mallory P. R. & Co. Inc. 0.016 0.000105 -0.42002
Memorex Corp. 0.504 0.004386 -0.62791
Minnesota Mng. & Mfg. Co. 0.052 0.000009 0.37477
Mobil Corp. 0.196 0.000029 0.07354
Ogden Corp. 2.600 0.01417 -0.91641
Pan Amem. World Awys. Inc. 0.048 0.000182 0.35709
Penney J. C. Inc. 0.065 0.000019 0.64488
Pepsico Inc. 1.700 0.000847 -2.48053
Pfizer Inc. 0.300 0.000055 0.63640
Philip Morris Inc. 2.300 0.000651 -0.54871
Pier 1 Imports Inc. 0.081 0.004405 0.02828
Reeves Bros. Inc. 0.023 0.000397 -0.03536
Republic Stl. Corp. 0.129 0.000248 0.70711
Robertshaw Ctls. Co. 0.060 0.000756 0.41295
Robins A. H. Inc. 0.228 0.000812 0.02546
Rockwell Intl. Corp. 0.570 0.000836 0.13930
162 D.B. Smith et al., Foreign sensitive payment disclosures

'Rollins Inc. 0.127 0.000455 -0.85843

Schaefer F. & M. Corp. 0.645 0.054631 -0.05657
Schering Plough Corp. 0.207 0.000073 1.16602
Schlumberger Ltd. 0.001 0.000000 0.29769
Scott Paper Co. 0.165 0.000225 - 0.67034
Shell Oil Co. 1.300 0.000238 -0.50558
Signode Corp. 0.450 0.001634 0.47942
Sperry Corp. 2.000 0.001248 0.60458
Squibb Corp. 1.900 0:001413 0.43770
Standard Oil Co. Ind. 0.600 0.000099 0.45821
Stauffer Chem. Co. 0.008 0.000008 -2.11284
Sun Inc. 0.698 0.000375 0.06081
TRW Inc. 0.175 0.000191 0.61165
Technicon Corp. 0.465 0.001745 -0.45184
United Technologies Corp. 1.800 0.002673 -0.51477
Upjohn Co. 2.700 0.002005 0.20506
Warner Lambert Co. 2.200 0.000740 -0.50982
Williams Cos. 0.854 0.001534 0.68307
Witco Chem. Corp. 0.765 0.004523 1.25653
Xerox Corp. 0.700 0.000156 -0.13435
Zapata Corp. 0.030 0.000386 1.22188
Average 1.156 0.00627 - 0.16208
Median 0.455 0.00078 - 0.03442

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