The Role of Information Transparency in the Product Market: An Examination of the Sustainability of Profitability Differences

Abstract

We investigate whether information transparency at the industry level is associated with the sustainability of within-industry differences in profitability. Since competitive actions lead to the elimination of intra-industry profitability differences, this investigation provides evidence on whether competitors act on information about their rivals. Using an industry-level transparency measure that integrates corporate reporting by firm managers, private information search and communication by analysts, and information dissemination by the media, we find that transparency is associated with faster reductions in within-industry profitability differences. Using aggregate financial statement data for public and private firms provided by the U.S. Census Bureau, we further find that differences in profitability between public and private firms are less persistent when public firms’ profitability exceeds private firms’ profitability, consistent with theoretical and anecdotal arguments that public firms are at a competitive disadvantage because they are required to be more transparent than their private firm counterparts. Our results are robust to the use of local newspaper closures and mergers as exogenous shocks to transparency. Collectively, these findings indicate that information transparency facilitates the competitive forces that lead to the erosion of profitability differences within an industry. We further demonstrate that information transparency is positively associated with the degree to which competitors enter or exit an industry in anticipation of changes in the industry’s profitability outlook.

Keywords: Information Transparency, Profitability Convergence, Proprietary Costs, Earnings Persistence, Product Market Competition, Abnormal Profits

JEL Classification: D41, D80, L15, M41