Financial Reporting Frequency, Information Asymmetry, and the Cost of Equity

Posted by R. Christopher Small, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Thursday November 8, 2012 at 9:58 am
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Editor’s Note: The following post comes to us from Renhui Fu of the Rotterdam School of Management at Erasmus University, Arthur Kraft of the Cass Business School at City University London, and Huai Zhang of the Nanyang Business School at Nanyang Technological University.

In our paper, Financial Reporting Frequency, Information Asymmetry, and the Cost of Equity, forthcoming in the Journal of Accounting and Economics, we examine the impact of financial reporting frequency on information asymmetry and the cost of equity. While it may seem obvious that more frequent disclosures will reduce information asymmetry and the cost of equity, this issue is more complicated. For one, more frequent financial reporting may encourage sophisticated investors to engage in private information acquisitions, resulting in a greater information asymmetry among investors. Alternatively, requiring more frequent reporting may reduce managerial voluntary disclosures, leading to a net loss of information. As such, it is an empirical question.

Empirical evidence, however, is difficult to come by due to the fact that after 1970, all firms in the on a quarterly basis, making it impossible to observe variations in reporting frequency. To overcome this obstacle, we hand collect reporting frequency data for U.S. firms for the years between 1951 and 1973. During these years, there is substantial variation in the reporting frequency since many firms report more frequently than required by the SEC. (The SEC required annual reporting in 1934, semi-annual reporting in 1955 and quarterly reporting in 1970).

The empirical results in the paper suggest that firms with higher reporting frequency have lower information asymmetry/cost of equity. We obtain similar inferences from a simple OLS regression, a firm fixed effects model, and a two-stage procedure. (The latter two approaches are employed to address the endogeneity associated with the choice of reporting frequency.) Results from the two-stage procedure suggest that an increase of one in the reporting frequency on average reduces our information asymmetry measure, the price impact, by 0.216% and the cost of equity measure based on the CAPM model by0.628%.

We also use a matched control sample approach, comparing changes in information asymmetry/cost of equity between firms changing their reporting frequency and firms keeping their reporting frequency (control firms). The results show that information asymmetry and the cost of equity decrease significantly for firms that increase their reporting frequency relative to control firms, regardless of whether the increase in reporting frequency is voluntary or mandatory. The results related to decreases in reporting frequency are much weaker, most likely because decreases in reporting frequency are typically temporary and do not reflect a commitment to reduced disclosures.

Overall, this study contributes to the accounting literature and may be relevant to practitioners and security regulators who are interested in exploring the consequences of higher financial reporting frequency.

The full paper is available for download here.


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