Earnings Quality and Information Asymmetry: Evidence from Trading Costs

53 Pages Posted: 11 Sep 2008  

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: September 3, 2008

Abstract

The adverse consequences of poor earnings quality have been the subject of significant debate among academics, practitioners and regulators. However, the empirical evidence on pricing implications of earnings quality is sparse and controversial. We examine one potential consequence of poor earnings quality - its impact on information asymmetry. We document that poor earnings quality increases the adverse selection risk as manifested in trading costs and lowers liquidity in financial markets. Both innate and discretionary components of earnings quality contribute significantly to information asymmetry. Further, poor earnings quality exacerbates information asymmetry around earnings announcements, especially for firms where earnings represent the principal source of information for market participants, suggesting that poor quality earnings offers a greater information advantage to informed traders. An important implication is that earnings quality can affect cost of capital via its impact on trading cost. Additionally, from a policy perspective, we show that earnings quality can lead to significant variation in information asymmetry even for firms within a uniform reporting regime.

Keywords: Earnings quality, information asymmetry, transactions costs, cost of capital

JEL Classification: G12, G14, M41, M43, M44, D82

Suggested Citation

Bhattacharya, Neil and Desai, Hemang and Venkataraman, Kumar, Earnings Quality and Information Asymmetry: Evidence from Trading Costs (September 3, 2008). Available at SSRN: https://ssrn.com/abstract=1266351 or http://dx.doi.org/10.2139/ssrn.1266351

Neil Bhattacharya

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 (Contact Author)

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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