Many types of business activities, such as new product launches, can fall outside the range of traditional accounting measures. This means investors relying on bottom-line earnings may not get the full picture. An alternative is to consider annual 10-K reports, a mandatory requirement of the Securities and Exchange Commission which give a comprehensive but often complex accounting overview. Do investors bother with 10-K reports?

A study by Haifeng You of HKUST and his co-author Xiao-Jun Zhang suggests the answer is, not as much as they should. Investors tend to underreact to 10-K reports even though they contain information that tends to predict future accounting profitability.

"At the time a company files its 10-K report, most likely all key information has already been disclosed to the public. Earnings per share, sales growth and other summary measures are often disclosed in earnings releases and conference calls weeks or even months before. As a result, investors often view the filing of 10-K as a formality and they largely ignore it," the authors say.

However, as noted, the 10-K still has useful information for investors. The authors suggest the significant amount of effort required to unearth that information amid all the details in the 10-K may be the reason why investors underreact.

"A key feature of the information in the 10-K is the large volume and high degree of complexity. Deciphering the footnotes on options, deferred taxes, and pensions requires special knowledge and expertise. The increased difficulty can be quite challenging to the average investor and might contribute to investors' underreaction."

Evidence supporting these ideas is found in an examination of 24,269 10-K reports filed during the period 1995 to 2005. Using the three-day abnormal stock return around the 10-K filing date as a measure of the information content of 10-K reports, the authors show that stocks disclosing good news in 10-K reports tend to experience price increases relative to their peers during the following 12 months, while those with bad news tend to drift downwards.

The magnitude of the delayed response also increases over time. At three, six and twelve months after the filing date, stocks with good news have seen their returns accrue by 1.49 per cent, 2.76 per cent and 4.25 per cent, respectively. Stocks with bad news, though, have fallen by 0.82 per cent, 3.20 per cent and 6.38 per cent over the same time period.

The authors found that investor underreaction to 10-K reports may be due to the complexity of the reports. Using the word-count of reports as a measure of complexity, they show that significant delayed reactions only exist among firms with more complex 10-K reports.

"Our findings imply that only 56 per cent of the market reaction takes place around the 10-K filing for the high complexity group. A sizeable proportion of the 10-K information is gradually incorporated into the stock price over the subsequent 12 months," they say.

"Overall our results indicate that the complexity of accounting information does affect the extent to which investors can incorporate such information into price. This lends support to making 10-K information more intelligible to the average investor."