Abstract

In this paper, I investigate the association between increased accounting disclosures and bid-ask spreads in an emerging market (China). I hypothesize that the implementation of new auditing standards in emerging markets would result in increased disclosures and a subsequent reduction in information asymmetry. I report the following primary findings. First, I find that adverse selection component accounts for about 37% of the total relative spread, indicating that information asymmetry cost is substantial in the emerging market. Second, after controlling for various firm characteristics and other market liquidity variables, I find in the cross-sectional analysis that Chinese companies experienced significant reduction in bid-ask spread subsequent to their adoption of new auditing standards. The sensitivity test shows that these results remain significant for the first set of auditing when the simultaneous effects of disclosure on trading volume and price volatility is considered. Third, after controlling for the concurrent effects of trading volume and price volatility, time-series intervention analyses show that the reductions in bid-ask spreads were significant and permanent. A sensitivity test of dummy events introduced on the first trading date of the fourth quarter of each year yields substantially different results, indicating that the significant downward interventions in bid-ask spreads are not driven by any systematic changes in the market microstructure. In addition, I find that the B-share market, where international auditing standards had been applied, experienced significantly less changes in the bid-ask spreads than A-share market. The results have implications for the standard-setters and regulators in emerging markets.

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