Discussion of The Economic Consequences of Increased Disclosure

Abstract

The basis for the study by Leuz and Verrecchia (hereafter LV) is the link between information asymmetries, market liquidity, and the cost of capital. The theory states that information asymmetries among market participants reduce expected liquidity in the market for a firm's shares through the introduction of adverse selection. The reduction in liquidity raises transaction costs and ultimately the cost of capital. Previous empirical research that has studied the correlation between disclosure levels and the information asymmetry component of the cost of capital has produced mixed results, perhaps because measuring both (changes in) disclosure levels and the information asymmetry component of the cost of capital of firms is very difficult. LV observe that an additional explanation for the mixed results might be that the power of the tests in the previous studies is weakened because they focus on the U.S. capital market, which is characterized both by high liquidity and by a high level of disclosure. As a consequence, commitments to additional disclosure in this context could lead to relatively small benefits that may not be measured accurately. LV present an innovative extension of the current empirical disclosure literature by focusing on the German capital market setting. German accounting standards and