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Review of Accounting Studies

Erschienen in:

01.09.2007

How disclosure quality affects the level of information asymmetry

verfasst von: Stephen Brown, Stephen A. Hillegeist

Erschienen in: Review of Accounting Studies | Ausgabe 2-3/2007

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Abstract

We examine two potential mechanisms through which disclosure quality is expected to reduce information asymmetry: (1) altering the trading incentives of informed and uninformed investors so that there is relatively less trading by privately informed investors, and (2) reducing the likelihood that investors discover and trade on private information. Our results indicate that the negative relation between disclosure quality and information asymmetry is primarily caused by the latter mechanism. While information asymmetry is negatively associated with the quality of the annual report and investor relations activities, it is positively associated with quarterly report disclosure quality. Additionally, we hypothesize and find that that the negative association between disclosure quality and information asymmetry is stronger in settings characterized by higher levels of firm-investor asymmetry.

Vorheriger Artikel Discussion of investor protection and analysts’ cash flow forecasts around the world

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In addition, prior studies commonly rely on the closing bid-ask spread. However, Madhavan, Richardson, and Roomans (1997) show that adverse selection costs decrease throughout the day, which suggests that the closing spread is a relatively weak proxy for information asymmetry.

The PIN methodology is used frequently in the finance literature and has been used by Botosan and Plumlee (2004), Brown, Hillegeist, and Lo (2004) and Hillary (2006) in the accounting literature.

The level of firm-investor information asymmetry is only relevant to the extent that it increases asymmetry among investors, such as through insider trading.

Also see Fama and Laffer (1971) and Hakansson (1977) for settings where public disclosure deters traders from expending resources on information collection for speculative purposes.

In assuming that the type of news is unambiguous, the EKO model does not allow for both informed buying and selling on the same day, as in Kim and Verrecchia (1991); private information is one-sided, as in Kyle (1985). In addition, the precision of the private information (vis-à-vis the precision of the public information) does not matter since informed traders are assumed to be risk neutral.

The model ignores the size of each trade order. While this simplifying assumption likely results in the loss of some information, the reduction may be minor as informed investors disguise their information by mimicking the trade sizes of uninformed traders (Barclay & Warner, 1993; Chakravarty, 2001). Also, see Jones, Kaul, and Lipson (1994).

The Inverse Gaussian distribution has mean =[W _t] = 1 and \({\hbox{variance}=\hbox{Var}[W_{t}]=(1/\psi^{2})}\). As the variance of the daily scaling factor W _t approaches zero (or equivalently, as ψ approaches infinity), W becomes a constant equal to one. When this occurs, the extended model simply reduces to the basic EKO model. In our sample, the median (95th percentile) value of ψ is 2.7 (4.1), and only four observations have values of ψ > 8. Thus, the extended model fits the trade order data significantly better than the basic EKO model.

This estimation procedure assumes that the underlying information environment, and hence parameters, remains relatively stable over an annual period. Easley et al. (2002) conclude that this assumption is reasonable as individual stocks exhibit relatively low variability in PINs across years and the cross-sectional distribution of PIN is quite stable across time. In addition, they estimated PINs using rolling 60 day sample periods and found them to be quite similar to the annual estimates. Thus, we conclude that it is reasonable to estimate PINs over an annual period.

Prior studies using the AIMR disclosure scores include Botosan and Plumlee (2002), Gelb and Zarowin (2002), Healy et al. (1999), Lang and Lundholm (1993), Lang and Lundholm (1996), Lundholm and Myers (2002), Sengupta (1998), and Welker (1995). Detailed discussions of the AIMR rating process and the disclosure scores can be found in Lang and Lundholm (1993) and Healy et al. (1999).

Despite these potential difficulties, we also conduct a 3SLS analysis as an alternative methodological approach. The results from this approach are consistent with our main results and are discussed in Sect. 5.6.

Lang and Lundholm (1993) use the signed values of Return and Surprise rather than the absolute values. Using signed values does not alter our results qualitatively.

We measure Size, InstOwn, and Owners at the end of the fiscal year as an estimate of the average level of these variables during the annual measurement periods for PIN and the AIMR scores.

Consistent with heterogeneity among institutional investors, Brown et al. (2004) find that the association between institutional ownership and PIN changes from quarter to quarter.

However, Jiambalvo et al. (2002) find that the number of analysts is negatively related to the extent that prices reflect future earnings, which suggests that analyst following is negatively related to the amount of informed trading.

The fraction of privately informed trades on information event days = \({\nu/(\nu+2)=0.89/2.89 \approx 0.31.}\)

There are four extreme values where the estimated value of ψ is around 2,000—a corner solution that occurs when the basic EKO model describes the underlying trade data reasonably well. However, diagnostic tests confirm that these cases do not result in extreme estimates of PIN or the PIN parameters.

All reported t-statistics are based on clustered standard errors where outliers based on abs(dfits) >0.1 are eliminated (Belsley, Kuh, & Welsch, 1980).

While Brown et al. (2004) report a significantly positive coefficient on institutional ownership in their pooled sample where PIN is estimated using the basic EKO model, institutional ownership has a significantly negative coefficient in several of their quarterly regressions.

The correlation between Analysts and Size is also quite large (0.69), and this multi-collinearity could also be responsible for the lack of significance for Analysts.

Malkiel and Radisich (2001) report that throughout the 1990s, 30% of institutionally managed assets were indexed, suggesting that a substantial amount of institutional trading was not based on private information.

In comparing a small group of high- and low-analyst firms, Easley et al. (1998) provides univariate evidence that both uninformed and informed trading is higher in the high-analyst group than in the low-analyst group. However, they do not discuss or analyze the ratio of the two variables.

Botosan and Plumlee (2002) also find a negative association between annual report quality and the estimated cost of equity capital, consistent with the negative PrAnnual coefficient we report here. However, they do not find a significant association with the IR score, in contrast with the significantly negative association we find here.

The levels of statistical significance that we find on the PrQuarterly and PrIR coefficients are somewhat sensitive to deletion of outliers. However, in all cases the coefficients are negative in the ɛ and μ equation and in no case were they significantly different from zero (or from each other) in the ν equation.

This supports our decision to treat the relation between them as endogenous. Untabulated results indicate that the PIN coefficient is significantly positive in the disclosure quality regression. Accordingly, we infer that managers take the level of information asymmetry into account when they make their disclosure quality choices.

They also find that the negative association between the number of management forecasts and information asymmetry is significantly stronger in the post-Regulation FD period.

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Titel: How disclosure quality affects the level of information asymmetry
verfasst von: Stephen Brown
Stephen A. Hillegeist
Publikationsdatum: 01.09.2007
Verlag: Kluwer Academic Publishers-Plenum Publishers
Erschienen in: Review of Accounting Studies / Ausgabe 2-3/2007
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-007-9032-5

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