Title

Does Earnings Quality and Information Asymmetry? Evidence from Trading Costs

Publication Type

Journal Article

Publication Date

2012

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 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.

Discipline

Accounting | Corporate Finance

Research Areas

Financial Intermediation and Information

Publication

Contemporary Accounting Research

Volume

30

Issue

2

First Page

482

Last Page

516

ISSN

0823-9150

Identifier

10.1111/j.1911-3846.2012.01161.x

Publisher

Wiley