Clarity Begins at Home: Internal Information Asymmetry and External Communication Quality

Posted: 24 Jun 2015 Last revised: 5 May 2017

See all articles by Chen Chen

Chen Chen

Monash University - Department of Accounting

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Sugata Roychowdhury

Boston College

Xin Wang

The University of Hong Kong

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance

Date Written: May 4, 2017

Abstract

This paper investigates the effect of internal information asymmetry (hereafter IIA) within conglomerate firms on the quality of management forecasts and financial statements. We develop a novel measure to capture IIA between divisional managers and top corporate managers, computed as the difference in their respective trading profits on their own company’s stock (DIFRET). Numerous validation tests indicate that DIFRET indeed captures the information asymmetry between divisional managers and top managers. In our primary tests, we find that DIFRET is associated negatively with the accuracy, bias, specificity and frequency of management forecasts. Furthermore, the likelihood of error-driven accounting restatements increases with DIFRET. Our results thus suggest that external communication quality suffers when the information asymmetry between divisional managers and top managers is more severe.

Keywords: Internal information asymmetry, management forecasts, accounting restatements

JEL Classification: G1, G30, M40, M41, M44

Suggested Citation

Chen, Chen and Martin, Xiumin and Roychowdhury, Sugata and Wang, Xin and Billett, Matthew T., Clarity Begins at Home: Internal Information Asymmetry and External Communication Quality (May 4, 2017). The Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2621753 or http://dx.doi.org/10.2139/ssrn.2621753

Chen Chen

Monash University - Department of Accounting ( email )

Building H, Level 3
Caulfield campus
Melbourne, Victoria 3800
Australia

Xiumin Martin (Contact Author)

Washington University in Saint Louis - Olin School of Business ( email )

Saint Louis, MO 63130
United States

Sugata Roychowdhury

Boston College ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617-552-1764 (Phone)

Xin Wang

The University of Hong Kong ( email )

1215 K.K.Leung Building
Hong Kong
Hong Kong

Matthew T. Billett

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States
812-855-3366 (Phone)

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