Abstract
We find that firms with higher quality disclosures have lower effective bid-ask spreads and lower adverse selection spread components. In contrast, we also find that firms with higher quality disclosures have lower quoted depths, resulting in no unambiguous conclusion regarding market liquidity and disclosure quality. These results illustrate the importance of examining both spreads and depths when studying market liquidity. We reconcile these seemingly conflicting results by performing a series of tests involving trade sizes and depths. We conclude that a policy of higher quality disclosures does, indeed, enhance a firm's market liquidity. In addition, our analyses suggest it is the quality of accounting information, rather than management's private communications with analysts, that drives relations between information quality and market liquidity. Thus our results suggest high quality accounting information, publicly available to all investors, helps reduce information asymmetry.
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