Disclosure Quality and Market Liquidity: Impact of Depth Quotes and Order Sizes

Posted: 9 Aug 2005

See all articles by Frank Heflin

Frank Heflin

University of Georgia - J.M. Tull School of Accounting

Kenneth W. Shaw

University of Missouri at Columbia - School of Accountancy

John J. Wild

University of Wisconsin - Madison - Department of Accounting and Information Systems

Abstract

We study the relation between disclosure policy and market liquidity. Our tests examine how two key aspects of market liquidity, the effective bid-ask spread and quoted depth, relate to financial analysts' ratings of firms' disclosure policies. We introduce a method of combining order sizes and depth quotes to yield more precise estimates of effective spreads on trades likely constrained by quoted depth. We find that while firms with higher rated disclosures are charged lower effective spreads, they are also quoted lower depth, consistent with the notion that better disclosures reduce information asymmetry but cause some liquidity suppliers to exit the market (e.g. Diamond and Verrecchia 1991). Thus, a simple examination of spreads and depths yields ambiguous inferences on the relation between disclosure policy and market liquidity. We resolve this ambiguity by estimating depth-adjusted effective spreads, and find that firms with higher rated disclosures have lower depth-adjusted effective spreads across all trade sizes. Overall, our results suggest a robust inverse relation between disclosure ratings and effective trading costs. Thus, a policy of enhanced financial disclosure is related to improved market liquidity.

JEL Classification: M41, M45, D82, G12, G30

Suggested Citation

Heflin, Frank and Shaw, Kenneth W. and Wild, John J., Disclosure Quality and Market Liquidity: Impact of Depth Quotes and Order Sizes. Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=771605

Frank Heflin (Contact Author)

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States
706-542-1616 (Phone)
706-542-3630 (Fax)

Kenneth W. Shaw

University of Missouri at Columbia - School of Accountancy ( email )

420 Cornell Hall
Columbia, MO 65211
United States
573-882-5939 (Phone)
573-882-2437 (Fax)

John J. Wild

University of Wisconsin - Madison - Department of Accounting and Information Systems ( email )

Wisconsin School of Business
975 University Avenue / Grainger Hall
Madison, WI 53706
United States
608-262-8122 (Phone)

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