Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs

54 Pages Posted: 15 Feb 2007 Last revised: 3 Jul 2013

See all articles by Neil Bhattacharya

Neil Bhattacharya

Singapore Management University - School of Accountancy; Southern Methodist University (SMU) - Accounting Department

Hemang Desai

Southern Methodist University (SMU) - Accounting Department

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: December 25, 2011

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.

Keywords: Earnings Quality, Information Asymmetry, Liqudity, Cost of Capital

JEL Classification: G12, G14, M41, M43, M44

Suggested Citation

Bhattacharya, Neil and Desai, Hemang and Venkataraman, Kumar, Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs (December 25, 2011). Contemporary Accounting Research, Vol. 30, No. 2, 2013. Available at SSRN: https://ssrn.com/abstract=1105160 or http://dx.doi.org/10.2139/ssrn.1105160

Neil Bhattacharya (Contact Author)

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

Southern Methodist University (SMU) - Accounting Department ( email )

United States
214-768-3082 (Phone)
214-768-4099 (Fax)

HOME PAGE: http://www.cox.smu.edu

Hemang Desai

Southern Methodist University (SMU) - Accounting Department ( email )

United States
214-768-3185 (Phone)
214-768-4099 (Fax)

Kumar Venkataraman

Southern Methodist University (SMU) - Finance Department ( email )

United States
214-768-7005 (Phone)
214-768-4099 (Fax)

HOME PAGE: http://people.smu.edu/kumar/

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