Disclosure Quality and Information Asymmetry

Disclosure Quality and Information Asymmetry
Author(s): Brown, Stephen and Hillegeist, Stephen A.
Year: 2005
Paper Number: GBS-ACC-2005-001
Goizueta Department: Accounting

Abstract

We examine the association between firms' disclosure quality and information asymmetry using a three-stage least squares estimation procedure that takes into account the endogeneity between these two variables. Our measure of information asymmetry is based on the Probability of Informed Trade (Easley, Kiefer and O'Hara [1997]), which measures the probability of information-based trade. Our primary result demonstrates that firms' overall disclosure quality is negatively associated with information asymmetry. This negative association continues to hold for each of the three major components of disclosure quality (Annual, Quarterly, and IR). Further analyses indicate that the underlying source of this negative association is primarily a negative association between disclosure quality and the relative amount of trading by privately-informed investors. Since prior work indicates that the cost of equity capital is increasing with information asymmetry, our results suggest that firms with higher disclosure quality have lower costs of capital.