Title

Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs

Publication Date

2-15-2007

Abstract

Information asymmetry in financial markets relates to the idea that one party to a transaction has better information than the other. Since financial reporting involves the transmission of value relevant enterprise information, we investigate whether the quality of reported earnings can contribute to differentially informed financial market participants. Higher information asymmetry is costly as it increases the adverse selection risk for market participants and lowers liquidity. For a large sample of NYSE and NASDAQ firms, we show that (i) poor earnings quality is significantly and incrementally associated with higher information asymmetry, (ii) earnings quality disproportionately affects information asymmetry for firms with poor information environments, (iii) both innate and discretionary components of earnings quality increase information asymmetry, and (iv) poor earnings quality exacerbates the information asymmetry around earnings announcements. Our results suggest that the standard setters’ efforts to develop accounting standards that improve earnings quality should contribute to a better information environment for market participants and increase stock liquidity.

Document Type

Article

Keywords

Earnings Quality, Information Asymmetry, Liqudity, Cost of Capital

Disciplines

Finance

DOI

10.2139/ssrn.1105160

Source

SMU Cox: Finance (Topic)

Language

English

Share

COinS