Changes In Information Asymmetry Research Articles

Internal control reporting and market liquidity

We investigate the impact of the Sarbanes-Oxley Act of 2002 (SOX) on information asymmetry by analyzing the relation between SOX Sections 302 and 404 control reports and market liquidity using bid-ask spreads. Lower market liquidity indicates higher levels of information asymmetry implying that market participants perceive financial statement misstatement risk is higher. If SOX disclosures contain relevant information, then one would expect firms reporting internal control material weaknesses to have lower market liquidity. Accordingly, we find that market liquidity is lower (i.e., bid-ask spreads are higher) for firms reporting ineffective control compared to firms reporting effective control using either annual SOX 404 internal control reports or quarterly SOX 302 disclosure control reports, which suggests that SOX 302 and 404 reports provide useful information for identifying firms with a higher risk of financial statement misstatement. However, we do not find consistent results using two alternative liquidity measures: trading volume and market quality indices. We then examine whether changes in control reports are associated with changes in market liquidity. We generally do not find that firms with improved (deteriorated) control reports experience a larger decrease (increase) in bid-ask spreads or larger increases (decreases) in trading volume and market quality indices compared to other firms, suggesting that market participants do not discern a change in information asymmetry when the effectiveness of internal controls over financial reporting changes.

Discussion of Consequences and Institutional Determinants of Unregulated Corporate Financial Statements: Evidence from Embedded Value Reporting

Serafeim [2011] examines the determinants and economic consequences of embedded value (EV) reporting, a voluntary disclosure arrangement in the life insurance industry. He finds substantial reductions in bid-ask spreads for EV reporting firms, and links the occurrence of this disclosure practice to the nature of competition in the insurance business. In my discussion, I focus on two aspects of his hypothesis development: (1) does EV reporting give rise to a credible commitment to transparency? (2) What are the country-level determinants of EV reporting? First, on a conceptual level, I highlight the distinction between an ex ante commitment to transparency and ex post voluntary disclosure. To illustrate my point, I examine the change in information asymmetry around various voluntary disclosure choices with varying degrees of commitment. I find a reduction in bidask spreads following U.S. cross-listings and the voluntary adoption of IFRS, but not after a switch to a Big Five auditor. These results let me gauge the magnitude of the effects for EV reporting. Second, I discuss the notion of complementarities among the elements of a country’s institutional environment. I then empirically show that institutional forces likely act both ways, i.e., from a single industry to the rest of the economy and vice versa, and that EV reporting is not independent from other voluntary commitment devices in a country. In sum, my findings underscore the importance of (and difficulties in) cleanly identifying the determinants and effects of voluntary disclosure choices. JEL classification: G14, G15, G30, K22, M41, M42

Discussion of Consequences and Institutional Determinants of Unregulated Corporate Financial Statements: Evidence from Embedded Value Reporting

Serafeim [2011] examines the determinants and economic consequences of embedded value (EV) reporting, a voluntary disclosure arrangement in the life insurance industry. He finds substantial reductions in bid-ask spreads for EV reporting firms, and links the occurrence of this disclosure practice to the nature of competition in the insurance business. In my discussion, I focus on two aspects of his hypothesis development: (1) does EV reporting give rise to a credible commitment to transparency? (2) What are the country-level determinants of EV reporting? First, on a conceptual level, I highlight the distinction between an ex ante commitment to transparency and ex post voluntary disclosure. To illustrate my point, I examine the change in information asymmetry around various voluntary disclosure choices with varying degrees of commitment. I find a reduction in bid-ask spreads following U.S. cross-listings and the voluntary adoption of IFRS, but not after a switch to a Big Five auditor. These results let me gauge the magnitude of the effects for EV reporting. Second, I discuss the notion of complementarities among the elements of a country’s institutional environment. I then empirically show that institutional forces likely act both ways, i.e., from a single industry to the rest of the economy and vice versa, and that EV reporting is not independent from other voluntary commitment devices in a country. In sum, my findings underscore the importance of (and difficulties in) cleanly identifying the determinants and effects of voluntary disclosure choices.

The Effect of Director Monitoring on Bid and Ask Spreads

ABSTRACT: We examine whether the market assesses a lower level of information asymmetry to firms that are perceived to be monitored more intensely by members of the board of directors. We use changes in bid-ask spreads as proxies for changes in information asymmetry between the firm and the market around the time earnings are announced. Our study is innovative in its association of director monitoring with levels of information asymmetry as reflected in quoted spreads.Our sample includes 145 firms included in the Toronto Stock Exchange 300 Index (TSX-300). The TSX’s hybrid market structure provides a unique international setting in which to examine the effects of governance on information asymmetry. Results indicate that the market attributes a lower level of information asymmetry to firms with a larger proportion of outside directors on the board. Contrary to our predictions, we find the larger the proportion of voting rights held by directors, the higher the level of information asymmetry attributed to the firm. We provide some evidence that a separate CEO/Chair leadership structure is associated with reduced information asymmetry. From a practice perspective, we are able to provide some preliminary insight into the potential value attributed by market participants to the imposition of regulation surrounding certain director monitoring activities.

The price, liquidity and information asymmetry changes associated with new S&P 500 additions

PurposeUsing S&P 500 additions, the purpose of this paper is to test the permanence of abnormal returns around the index inclusion announcement and effective implementation dates to differentiate among competing explanations for the index inclusion premia puzzle.Design/methodology/approachThe event study methodology is used to examine abnormal returns and volume effects around the announcement dates (ADs) and implementation dates of index additions.FindingsThis study documents a twofold increase in trading volume and significant permanent abnormal returns at the ADs that are correlated with subsequent decreases in bid‐ask spreads. There is a fivefold increase in trading volume, but only temporary abnormal returns, around the effective dates (EDs). Taken collectively, the evidence indicates that the permanent return at announcement is best explained by liquidity/information cost explanation, but the temporary return and large trading increases at the ED can best be attributed to the price pressure hypothesis.Research limitations/implicationsThese results do not support the well documented long‐run downward‐sloping demand curve as the primary explanation for the abnormal returns observed on these dates.Originality/valueThis study contributes to the body of literature on the index inclusion effect by providing supporting evidence for the liquidity/information cost explanation, and by extending the previously analyzed index additions with an additional five‐year period from 2000‐2004.

Further Evidence on the Relation between Analysts' Forecast Dispersion and Stock Returns*

Prior research reports seemingly conflicting evidence and interpretations concerning the relation between dispersion in analysts' earnings forecasts and stock returns. Diether et al. (2002) and Johnson (2004) find a negative relation between levels of dispersion in analysts' forecasts and future stock returns. Yet, changes in forecast dispersion are negatively associated with contemporaneous stock returns (L'Her and Suret 1996). We demonstrate that levels and changes in dispersion reflect different theoretical constructs. Changes in dispersion primarily reflect changes in information asymmetry whereas levels of dispersion primarily reflect levels of uncertainty. Further, the uncertainty component of dispersion levels reflects idiosyncratic risk that is negatively associated with future stock returns. These findings provide support for Johnson's (2004) explanation that dispersion levels reflect idiosyncratic uncertainty that increases the option value of the firm and generally refute Diether et al.'s (2002) explanation that dispersion levels reflect information asymmetry. In addition, we reconcile L'Her and Suret's (1996) findings with the findings of Johnson (2004). We find that the negative association between changes in dispersion and contemporaneous stock returns is not due to increased uncertainty but rather increased information asymmetry.

The effect of earnings surprises on information asymmetry

We examine the effect of earnings surprises on changes in information asymmetry. We hypothesize and find that asymmetry is lower (higher) in the quarter following positive (negative) earnings surprises compared to firms that meet the consensus analyst earnings forecast. The relations between earnings surprises and information asymmetry are stronger when the surprises are more likely to capture investors’ attention. Examining the source of these changes, we show that decreased information search activities is the most important factor for asymmetry declining after positive surprises; for negative surprises, decreased uninformed trading plays a dominant role increasing asymmetry.

Management earnings forecasts and adverse selection cost: good vs bad news forecast

PurposeThe aim of this paper is to investigate the effect of management earnings forecasts on the level of information asymmetry around subsequent earnings announcement.Design/methodology/approachEmploying the adverse selection cost method suggested by George et al., the paper compares for each sample firm the adverse selection cost around earnings announcement in forecasting years with that in non‐forecasting years.FindingsConsistent with Diamond and Verrecchia is the finding that the earnings announcement in non‐forecasting years decreases information asymmetry during a three‐day announcement period and increases in a post‐announcement period up to seven days. No significant change in information asymmetry between pre‐ and post‐announcement periods when firms released a “good” news forecast is found. The firms that previously released a “bad” news forecast experience a significantly lower information asymmetry than those that did not forecast during announcement or post‐announcement days, and experience a decrease in information asymmetry in a five to seven‐day post‐announcement period.Originality/valueThis paper provides the first empirical reports on the different information asymmetry changes around earnings announcements followed by a “good” news management forecast from those followed by a “bad” news forecast.

The Effect of Earnings Surprises on Information Asymmetry

We examine the effect of earnings surprises on changes in information asymmetry. We hypothesize and find that asymmetry is lower (higher) in the quarter following positive (negative) earnings surprises compared to firms that meet the consensus analyst earnings forecast. The relations between earnings surprises and information asymmetry are stronger when the surprises are more likely to capture investors' attention. Examining the source of these changes, we show that decreased information search activities is the most important factor for asymmetry declining after positive surprises; for negative surprises, decreased uninformed trading plays a dominant role increasing asymmetry.

The Change in Corporate Transparency of Korean Firms After the Asian Financial Crisis: an analysis using analysts' forecast data

Using analysts' forecast error and forecast dispersion of firms covered by the I/B/E/S database, this study examines the change in information asymmetry of Korean firms around the financial crisis of 1997. Results show that the information asymmetry of Korean firms is lower after the financial crisis than before, implying that corporate transparency did, in effect, improve with the change in business environment. In addition, this study finds that chaebol firms have higher information asymmetry than non‐chaebol firm, and also that the corporate transparency improvement of chaebol firms is not higher than that of non‐chaebol firms in the post‐crisis period despite the reforms particularly targeted to chaebol firms after the financial crisis.

Trading Activity, Trade Costs and Informed Trading for Acquisition Targets and Acquirers

Microstructure effects of tender offer acquisitions on targets and acquirers differentiated by listing venue and payment method are examined. Trading activity increases more for targets than for acquirers upon offer announcement. Investors are more likely to sell targets upon announcement using direct market orders against ask limit orders for cash payment offers. While target liquidity improves as spread costs fall and quoted depths increase, acquirer liquidity falls continuously to successful offer completion. Due to increased trading differences, temporary trade costs fall more for targets than for acquirers. Permanent trade costs decline over the tender offer cycle for both parties, and especially for targets for cash tender offers and for acquirers for shares tender offers. The probability of informed trading declines (remains constant) for targets (acquirers) because increased trading intensity is greater (the same) for uninformed versus informed traders. As expected, abnormal returns and changes in own-firm permanent return volatility are negatively (but weakly) and positively (and strongly) related, respectively, to changes in information asymmetry upon announcement.

The Information Role of Conservatism

In this paper we argue that information asymmetry between firm insiders and outside equity investors generates conservatism in financial statements. Conservatism reduces the manager's incentives and ability to manipulate accounting numbers and so reduces information asymmetry and the deadweight losses that information asymmetry generates. This increases firm and equity values. Our empirical tests are consistent with our proposition that information asymmetry is significantly positively related to conservatism after controlling for other demands for conservatism. Further, our tests are more consistent with our prediction that changes in information asymmetry between equity investors lead changes in conservatism than the FASB's proposition that conservatism produces information asymmetry among equity investors. An important implication is that, if the FASB was successful in meeting their stated goal of eliminating conservatism, they would increase information asymmetry between investors, not reduce it. This outcome is inconsistent with the objectives of the Securities Acts.

Was the Introduction of IFRS in Europe Value-Relevant?

The introduction of IFRS in Europe was intended to improve accounting quality and facilitate cross-border financial transactions. This study examines whether IFRS increases value-relevance of corporate disclosure using traders' response in financial markets of 15 EU countries. If the regulatory reform improves informativeness of financial reporting, there will be a significant decrease in the bid-ask spread, and more particularly in its information asymmetry component (AIc). Using AIc of 3,907 companies in the period 2003-2005, we investigate how information asymmetry changes when legal origin, country earnings management and corporate disclosure scores differ. On average, the spread decreases over the period, whereas AIc does not. We suggest that IFRS adoption is positively associated with a significant increase in both size and volatility of AIc for UK firms. The increased and stable proportion of free float shares for UK and Scandinavian firms we also attribute to the regulatory change. It seems that AIc does not become more volatile under IFRS for French and Scandinavian origin groups, whereas it changes greatly for the UK and German groups. Our results show that firms with a higher country score for earnings management have a lower AIc. Additionally, higher disclosure is positively correlated with larger information asymmetry. Using aggregate AIc obtained with rolling regressions, we explain variance in information asymmetry with market value, spread size, volume, free float and returns. Our empirical results confirm that, when spread size increases, AIc decreases across the four country groups. The marginal effect of the spread size on information asymmetry is stronger for UK firms. We argue that although average bid-ask spread decreases over the period 2003-2005, it does not necessarily lead to a lower AIc in 2005.

The Information Role of Conservatism

In this paper we argue that information asymmetry between firm insiders and outside equity investors generates conservatism in financial statements. Conservatism reduces the manager's incentives and ability to manipulate accounting numbers and so reduces information asymmetry and the deadweight losses that information asymmetry generates. This increases firm and equity values. Our empirical tests are consistent with our proposition that information asymmetry is significantly positively related to conservatism after controlling for other demands for conservatism. Further, our tests are more consistent with our prediction that changes in information asymmetry between equity investors lead to changes in conservatism than the FASB's proposition that conservatism produces information asymmetry among equity investors. An important implication is that, if the FASB was successful in meeting its stated goal of eliminating conservatism, then it would increase information asymmetry between investors, not reduce it. This outcome is inconsistent with the objectives of the Securities Acts.

Information asymmetry surrounding earnings and dividend announcements: An intra-day analysis

This paper uses high frequency data to evaluate whether information asymmetry in the market is reduced subsequent to corporate earnings and dividend announcements. Changes in the level of information asymmetry due to the announcements are proxied by the rate of change in trading volume, bid-ask spread, cumulative abnormal returns, and order imbalance. Our results show that the release of earnings and dividend reduces information asymmetry, proxied by bid-ask spread and order imbalance. There is no significant change in trading volume. The significant change in cumulative abnormal returns suggests that the announcements have information content. Cross-sectional analysis shows that forecast errors and the timing of the announcements are somewhat related to the change in information asymmetry. Some interaction effects of earnings and dividend on the change in information asymmetry are documented.

The impact of the Internet on earnings announcements

This study examines the impact of the Internet on earnings announcements, in an Australian context, with relation to (1) information content (2) post-earnings announcement drift (PEAD) and (3) information asymmetry. Our results for the pre-Internet (1996) and the post-Internet (2000) periods provide mixed evidence on the changes in the information content of earnings announcements. However, we detect a reduction in both the magnitude and duration of the post-earnings announcement drift in the post-Internet period for the positive unexpected earnings decile. The analysis on abnormal volume, spread and market depth do not show a significant change in information asymmetry between the pre- and post-Internet periods for preliminary final announcements.

Earnings Announcements and Information Asymmetry: An Intra-Day Analysis

This paper examines the effect of earnings announcements on information asymmetry as perceived by specialists. We use changes in quoted bid-ask spreads and depths (relative to the average value in the non-announcement period) as proxies for changes in information asymmetry in the market. To our knowledge, we are the first to employ a model that captures the simultaneous nature of the specialists' choice of spreads and depths in reaction to earnings news. We provide evidence that spreads are wider and depths are smaller before the release of earnings announcements. We also find that changes to depths are greater for announcements of quarterly earnings than for announcements of annual earnings and changes to spreads persist longer into the post-announcement period when announcements are made outside trading hours. These changes to spreads and depths persist when earnings announcements are made after trading hours.

Earnings Announcements and Information Asymmetry: An Intra‐Day Analysis*

AbstractThis paper examines the effect of earnings announcements on information asymmetry as perceived by specialists. We use changes in quoted bid‐ask spreads and depths (relative to the average value in the non‐announcement period) as proxies for changes in information asymmetry in the market. To our knowledge, we are the first to employ a model that captures the simultaneous nature of the specialists' choice of spreads and depths in reaction to earnings news. We provide evidence that spreads are wider and depths are smaller before the release of earnings announcements. We also find that changes to depths are greater for announcements of quarterly earnings than for announcements of annual earnings and changes to spreads persist longer into the post‐announcement period when announcements are made outside trading hours. These changes to spreads and depths persist when earnings announcements are made after trading hours.

Regulation Fair Disclosure and Information Asymmetry

With the institution of Regulation Fair Disclosure (FD) on October 23, 2000, the Securities and Exchange Commission (SEC) imposed higher transparency requirements on the voluntary disclosure practices of public companies. This paper investigates whether the regulation induced companies to commit to higher or lower levels of voluntary disclosures by studying the changes in information asymmetry. The analysis is based on the extant economic theory suggesting that increases in the quantity and/or quality of disclosures should reduce companies' levels of information asymmetry. We study two proxies of information asymmetry - the probability of informed trading and the adverse selection component of the spread. After the implementation of Regulation FD we find a significant increase in both proxies of information asymmetry and the probability of new information events that contain private information while the proportion of informed traders decreases. An analysis of the volume of disclosures shows that the regulation was successful in increasing the quantity of available public information. Combined with the previous results we are able to conclude that, at least initially, companies responded to the regulation by providing more public information of lower quality.

Information conveyed by seasoned security offerings: evidence from components of the bid–ask spread

AbstractWe examine the relationship between the degree of informational asymmetry surrounding a firm and the equity market's reaction to a firm's announcement to sell seasoned securities. We use the adverse‐selection component of the bid–ask spread as a proxy for the informational asymmetry of a firm. For equity offers, we find that the greater the change in information asymmetry at announcement, the greater the decline in wealth. In addition, the largest decline in wealth for seasoned equity announcements is observed for firms with the largest level of pre‐event adverse‐selection components. For debt offers, the wealth decline is only significant for firms with the largest pre‐event levels of asymmetric information.