The Impact of Mandated Cash Flow Disclosure on Bid‐Ask Spreads

Abstract:   This study provides evidence that mandatory cash flow disclosure required by Approved Australian Accounting Standard AASB 1026, Statement of Cash Flows (June 1992) was associated with a decline in bid‐ask spreads following the introduction of the regulation, even after controlling for changes in trading volume and price volatility. More pronounced decreases in bid‐ask spreads were associated with firms having lower correlations between reported CFO and estimates of CFO using balance sheet reconstructions. We conclude that mandatory cash flow disclosure reduces information asymmetry across market participants.     

The Illiquidity of Corporate Bonds

This paper examines the illiquidity of corporate bonds and its asset‐pricing implications. Using transactions data from 2003 to 2009, we show that the illiquidity in corporate bonds is substantial, significantly greater than what can be explained by bid–ask spreads. We establish a strong link between bond illiquidity and bond prices. In aggregate, changes in market‐level illiquidity explain a substantial part of the time variation in yield spreads of high‐rated (AAA through A) bonds, overshadowing the credit risk component. In the cross‐section, the bond‐level illiquidity measure explains individual bond yield spreads with large economic significance.     

Adverse selection and the presence of informed trading

We combine two concepts of informed trading – contrarian trades and stealth trading – to develop proxies for the probability of informed trading. These proxies are used to test the link between informed trading and adverse selection as measured by bid–ask spreads and stock illiquidity. The estimation results show that these proxies, which are based on the probability of contrarian trading (PC) and progressively refined thereon, are all highly significantly positive in various empirical specifications of the cross-sectional determinants of spreads and illiquidity across stocks, and after controlling for important firm characteristics and trading factors. The robustness of our PC-based proxies for informed trading in these analyses, especially for the further refined measures, suggests that they successfully capture the adverse selection component of bid–ask spreads and illiquidity due to information asymmetry.     

ADVERSE SELECTION,SPREAD BEHAVIOR,AND OVER-THE-COUNTER SEASONED EQUITY OFFERINGS

In this paper the effects of over-the-counter seasoned equity issuances on the percentage bid-ask spreads around announcement and offer dates are examined. A declining spread in the pre-announcement period suggests that resolution of information asymmetry begins well before the announcement date. Further, using issue size as a proxy for the extent of information asymmetry, we observe that spreads for larger issues reach “normal” levels before the first public disclosure of the offering. For smaller issues this occurs only on the offer date. Results are consistent with the dealer experiencing reduced adverse information risk as a result of information-gathering efforts during the underwriting process.     

Information asymmetry and accounting disclosures for joint ventures

In September 1999, the Financial Accounting Foundation issued a special report recommending the use of the equity method supplemented with appropriate disclosures for corporate joint ventures in the United States. This study, using data for corporate joint ventures in Singapore, provides some preliminary evidence regarding the effect of the supplementary information disclosure on information asymmetry among market participants as measured by bid-ask spreads. The results show that the disclosure of supplementary information of joint ventures is associated with a significant decline in bid-ask spreads. The results also indicate that the decline in information asymmetry is larger when the investment in joint ventures is significant and that larger investing firms tend to have a smaller decline in information asymmetry compared to smaller investing firms. The implications of this study, that the provision of supplementary information about joint ventures could reduce information asymmetry among participants in equity markets, thus leveling the playing field among traders, could have implications for policymakers.     

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.     

Information asymmetry and accounting restatement: NYSE-AMEX and NASDAQ evidence

We examine the impact of accounting restatement announcement on firms’ value and information asymmetry for both auction market (NYSE-AMEX) and dealer market (NASDAQ) using a public sample of restatement announcements from 1997 to 2005. In both markets, we document economically and significantly negative mean cumulative abnormal returns around the announcement dates. The restatements attributed to auditors are associated with more negative returns than those attributed to management and the SEC. However, there is no significant difference between market reactions arising from the core and non-core restatements. We also find a significant increase in volume, number of transactions, average order size, volatility, and various measures of spreads after the restatement announcement indicating that restatement announcements diminish company prospects and contribute to increased uncertainty and information asymmetry. Finally, we find that the information asymmetry in the NASDAQ market around the event date is less pronounced than in the NYSE-AMEX market.     

Information Asymmetry and Voluntary SFAS 157 Fair Value Disclosures by Bank Holding Companies During the 2007 Financial Crisis

We hand‐collect SFAS 157 voluntary fair value disclosures of 18 bank holding companies. The SEC's Division of Corporate Finance likely targeted these entities in 2008 through their “Dear CFO” letters in which they requested specific, additional disclosure items. We collect disclosures that match the SEC recommendations and create eight common factor disclosure variables to examine the effect of such disclosures on information asymmetry. We find that disclosure variables about the use of broker quotes or prices from pricing services and the use of market indices and illiquidity adjustments are related to lower information asymmetry. However, disclosure variables about valuation techniques and asset‐backed securities are related to greater information asymmetry. We also document that disclosure complexity, and disclosure tone (uncertainty and litigious) is related to greater information asymmetry. These findings are consistent with criticism that corporate disclosures are voluminous; management may obfuscate unfavorable information which in turn increases market participants’ assessment of uncertainty associated with the fair value measures. We caveat that the setting of the financial crisis and a small sample size may limit the ability to generalize these inferences to other time periods or other financial firms.     

Auditing standards,increased accounting disclosure,and information asymmetry: Evidence from an emerging market

The interest in accounting disclosure and audit quality by academics, practitioners, and regulators heightened following the various financial reporting scandals, and subsequent legislative and professional response to these scandals. An important question is whether the implementation of stricter auditing standards such as those mandated by the US Sarbanes-Oxley Act would improve the information environment of firms whose shares are publicly traded. In this paper, I investigate the link between information asymmetry, measured by bid-ask spread, and increased accounting disclosures following the adoption of new auditing standards in China—an environment in which disclosure hitherto was relatively low. I report the following primary results of the statistical analyses. First, information asymmetry cost is substantial in the Chinese order-driven emerging markets. Second, the firms in the sample experienced significant reductions in their bid-ask spreads subsequent to the adoption of the new auditing standards. Third, the reductions in the bid-ask spreads were abrupt and permanent. However, no significant result is found for firms in the control group with foreign ownership, whose financial statements were prepared in accordance with international accounting standards and were audited with international auditing standards. The results have implications for policy makers and regulators in general, and those in emerging markets in particular.     

Real effects of financial reporting and disclosure on innovation

This paper reviews the literature on the real effects of financial reporting and disclosure on corporate innovation, highlighting both the possible channels of influence and the potential challenges that researchers face when attributing causal effects. We discuss the concept of innovation, emphasising the specific characteristics that make investments in innovation difficult to report. We then provide a review of the nascent work relating disclosure to innovation, which we organise around three channels: financing, compensation and learning. Finally, we discuss recent efforts aimed at increasing the quality of corporate disclosures, including disclosures of firms’ innovative activities. Throughout the paper, we highlight the trade-offs of disclosure (reduced information asymmetry and increased proprietary costs), which are particularly exacerbated in the context of corporate innovation.     

Information Disclosure and Stock Liquidity: Evidence from Borsa Italiana

This article examines the effect of increased corporate information disclosure on stock liquidity. Using the adoption of International Financial Reporting Standards (IFRS) in Italy as a natural experiment we extend previous work examining the effect on one measure of liquidity—bid‐ask spreads—to others, specifically depth and the price impact of transactions (or effective bid‐ask spreads). Consistent with previous research we find that bid‐ask spreads of stocks decline following the introduction of IFRS, which implies that stock liquidity increases for small traders. However, we also provide evidence that depth at the best quotes declines, which challenges the proposition that liquidity increases for large trades following an increase in disclosure. In additional tests, we find that effective bid‐ask spreads of block trades also decline following the introduction of IFRS. Overall, this evidence confirms that stock liquidity for both small and large trades increases following an increase in corporate information disclosure.     

柜台市场会计信息披露研究——国外文献述评与启示

会计信息披露是降低信息不对称的重要方式,柜台市场信息的不对称影响做市商的报价价差,从而影响市场的流动性。本文分别围绕会计信息披露对买卖价差的影响、会计信息披露对市场流动性的影响、会计信息披露与柜台市场有效性的关系三方面,对国外文献进行梳理和分析,并阐明会计信息披露对构建我国柜台市场的重要意义。     

Disclosure frequency and information asymmetry

The main purpose of this paper is to investigate whether more frequent disclosure by firms is associated with lower levels of information asymmetry among investors. Using a panel of 386 firms in the US retail sector, I find that the practice of regularly providing monthly revenue disclosures is not associated with reduced information asymmetry. In contrast, I find that more detailed (greater quantity) disclosure is associated with reduced information asymmetry. I provide preliminary evidence that the distinction between disclosure frequency and disclosure quantity is due to more frequent disclosure providing an incentive for increased private information acquisition by sophisticated investors. The results indicate that the relation between disclosure and information asymmetry is multi-dimensional and varies depending on the disclosure attribute being studied.     

Illiquidity and volatility spillover effects in equity markets during and after the global financial crisis: An MEM approach

Even though the volatility spillover effects in global equity markets have been documented extensively, the transmission of illiquidity across national borders has not. In this paper, we propose a multiplicative error model (MEM) for the dynamics of illiquidity. We empirically study the illiquidity and volatility spillover effects in eight developed equity markets during and after the recent financial crisis. We find that equity markets are interdependent, both in terms of volatility and illiquidity. Most markets show an increase in volatility and illiquidity spillover effects during the crisis. Furthermore, we find volatility and illiquidity transmission are highly relevant. Illiquidity is a more important channel than volatility in propagating the shocks in equity markets. Our results show an overall crucial role for illiquidity in US markets in influencing other equity markets' illiquidity and volatility. These findings are of importance for policy makers as well as institutional and private investors.     

Relationship Between Analyst Forecast Properties and Equity Bid‐Ask Spreads and Depths Around Quarterly Earnings Announcements

Abstract:   We study the relationships between three variables which proxy for the ex‐ante level of information asymmetry – forecast dispersion, forecast revision volatility, and the level of analyst coverage, and equity bid‐ask spread and depth changes around quarterly earnings releases. Kim and Verrecchia (1994) suggest that earnings releases increase the level of information asymmetry and lower the level of liquidity in the security market. Using both an OLS regression framework and a simultaneous equations model, we examine whether equity bid‐ask spreads increase and depths decrease as the level of information asymmetry increases. Our results indicate that spreads are higher (relative to a non‐event period) around earnings announcements when information asymmetry is more pronounced; however, depths are lower only on the day following the announcement when there is greater information asymmetry. Relative spreads have a significant positive relation with both forecast dispersion and revision volatility and a significant negative relation with analyst coverage. Relative depths have a significant negative relation with forecast dispersion and a significant positive relation with analyst coverage. Our findings indicate that the equity specialist adjusts both spreads and depths when confronting informed traders around earnings releases and that these adjustments are more pronounced when the level of information asymmetry is greater.     

Do Financial Markets Care about Corporate Social Responsibility Disclosure? Further Evidence from China

Corporations increasingly define their corporate social responsibility (CSR) activities as a part of their business. However, is this trend beneficial to investors? Based on an event study methodology and a sample of Chinese listed companies, we extend the literature on voluntary disclosure by exploring the role of CSR disclosure in reducing stock market information asymmetry, as proxied by share price volatility and liquidity. Our results show that the share price volatility after CSR disclosure is lower than before CSR disclosure; however, the trend is that it decreases first and then increases for three months following disclosure. Stock liquidity also significantly improves after CSR disclosure; however, it increases first and then decreases. Additionally, by dividing CSR disclosure into economic (hard) disclosure and generic (soft) disclosure, we find that the reduction in information asymmetry is higher for hard disclosure than soft disclosure, suggesting that although CSR disclosure does indeed have an impact on investors’ behaviour in China, an economic‐based disclosure contributes more substantially. Finally, to better understand the characteristics of the Chinese financial market, we also explore the role of marketisation with results that show that the effect in reducing information asymmetry is greater for companies located in a region with a higher degree of marketisation.     

The effect of price limits on intraday volatility and information asymmetry

We investigate the effect of price limits on intra-day volatility and information asymmetry using transactions data from the Taiwan Stock Exchange. Proponents of price limits argue that they provide an opportunity for investors to reevaluate market information and make more rational trading decisions. We identify three different limit hits – closing, single, and consecutive – and hypothesize that only the consecutive limit hits are likely to provide such an opportunity, namely, to counter investor overreaction (volatility hypothesis) and to enhance information revelation (information asymmetry hypothesis). Our empirical evidence supports the volatility hypothesis. Our findings generate important policy implications for stock markets that have price limits.     

Corporate disclosure quality and institutional investors' holdings during market downturns1

We examine institutional investors' responses to corporate disclosure quality conditional on market states. Transient institutions react more positively to corporate disclosure quality during market downturns than during normal market periods, as better disclosure practices lower information asymmetry and are thus associated with reduced uncertainty, enhanced liquidity, and weakened impacts of crises, which are the most desirable features of assets during market downturns. Dedicated institutions are insensitive to corporate disclosure quality in both normal and market downturn periods, as they have access to inside information and rely less on public disclosures. Their reliance on corporate disclosures in market downturns, however, increases sharply after the implementation of Regulation Fair Disclosure, which removes their inside information advantage. We further show that corporate disclosure reduces information asymmetry to a greater extent in market downturns than in normal market periods and that transient ownership in market downturns provides strong price support and stabilizes return volatility, whereas dedicated ownership does not possess such functions. Finally, we show that the results are not simply driven by endogeneity and are robust to alternative corporate disclosure quality measure and to the control of other determinants of institutional holdings.     

Exchange rate risk and transactions costs: Evidence from bid-ask spreads

This paper develops a model of exchange rate bid-ask spreads which is used to examine the relationship between exchange rate risk and volatility and to measure transactions costs. The empirical results indicate that market-makers judge the probability of exchange rate changes based on both recent and long-term volatility and that the second moment alone is not a complete measure of volatility. While a proxy for trading volume does not have the expected relationship with spreads, weekend and holiday effects conform to theory. Transactions costs vary over time and seem responsive to the imposition of exchange controls.     

Earnings Surprises in Analysts' Forecasts,Mandatory Disclosure,and Share Repurchases

This paper examines the impact of forecast errors and the mandatory disclosure of repurchase transactions required by 2003 Securities and Exchange Commission (SEC) regulations on share repurchases. We define forecast errors as the difference between analysts' forecasted earnings and actual earnings. We argue that firms with positive forecast errors imply greater information asymmetry, which may induce them to signal through share repurchases. We show that both the repurchase target and analysts' forecast revision are positively related to forecast errors. Furthermore, these associations are more pronounced in the low disclosure period (1989–2003) where greater information asymmetry between managers and outside investors is found, while increased transparency in the high disclosure period (2004–2006) leads to more significant improvement in long‐term performances for firms with positive forecast errors. The results are consistent with our expectations that the information asymmetry implied in forecast errors, along with a shock change from the introduction of the 2003 SEC regulation, affect both corporate and analysts' behaviour.