Earnings Opacity and Closed-End Country Fund Discounts

Abstract

Closed-end country funds are interesting in that they have two sets of prices for the same underlying assets – the net asset value (NAV) of the fund holdings as measured using the underlying firms’ stock prices in their home markets and the fund price at which the fund trades on a U.S. stock exchange. Utilizing the theoretical framework of information asymmetry in two separate markets for an identical asset, we find that the difference between the fund’s NAV and its trading price (i.e., the fund discount) is positively associated with the earnings opacity of the underlying companies. Such a positive association is consistent with the notion that U.S. investors face higher information acquisition and processing costs when compared with local investors and therefore earnings opacity exacerbates the information disadvantage of U.S. investors, leading to a larger fund discount. We further show that the positive relation varies predictably with U.S. investors’ information acquisition and processing costs and with the extent to which host stock markets are segmented from the U.S. market. Specifically, we find that the positive relation between earnings opacity and fund discounts is weaker for those funds with more U.S. cross-listings in fund holdings, with underlying companies following financial reporting standards similar to U.S. standards, and with less segmented local markets.