Transparency, Price Informativeness, and Stock Return Synchronicity: Theory and Evidence
Abstract: This paper argues that, contrary to the conventional wisdom, stock return synchronicity (or R2) can increase when transparency improves. In a simple model, we show that, in more transparent environments, stock prices should be more informative about future events. Consequently, when the events actually happen in the future, there should be less “surprise” (i.e., less new information is impounded into the stock price). Thus a more informative stock price today means higher return synchronicity in the future. We find empirical support for our theoretical predictions in 3 settings: namely, firm age, seasoned equity offerings (SEOs), and listing of American Depositary Receipts (ADRs).
Summary (3 min read)
- This paper argues that, contrary to the conventional wisdom, stock return synchronicity (or R2) can increase when transparency improves.
- The other is time-invariant, such as managerial quality.
- Listing events is the main focus of their empirical exercise and the authors find strong support for it in the data.
- First, the authors address the literature on transparency, informativeness of stock prices, and stock return synchronicity by arguing that a more transparent firm can have a higher return synchronicity, contrary to the conventional wisdom.
- 6 Lang and Lundholm (1996) examine the relation between firms’ disclosure policies, analyst following, and the accuracy of analysts’ forecasts.
- Here, captures market factors that are observed by all; tf t,1θ and t,2θ are firm-specific shocks.
- Outsiders only observe t,1θ , whereas insiders observe both t,1θ and t,2θ .
- The authors now depart from Jin and Myers (2006) by assuming that there is a change in the firm’s disclosure policy and the firm becomes more transparent.
A.1. Lumpy (One-Time) Information Disclosure
- During SEOs or ADR listings, the firm becomes more transparent in the sense that a big chunk of information comes out that otherwise would have come out later, or perhaps not at all.
- For simplicity of exposition, the authors make the extreme assumption that the information revealed at disclosure affects only the cash flow shock one period later, i.e. it is relevant for events that occur one period later only.
- 0t Proposition 1(a). (i) The proportion of the realized variation in period (i.e. between and0t 0t 10 +t ) explained by market factors is higher for a firm that experience an improvement in disclosure at than one that does not.
- The return synchronicity will increase subsequently – there is less information content to later announcements since part of the information is already impounded in the stock price.
A.2. Regular Early Disclosure of Information
- To formalize this notion of transparency, the authors assume that at the beginning of every period, there is some disclosure that reduces the variance of the cash flow shock revealed to the public at the end of the period.
- The result that the return synchronicity actually increases in this case may be somewhat surprising.
- The reason is that the information revealed at the end of the period regarding the cash flow innovation still one period later is discounted relative to the information revealed at the beginning of the period, since the former is relevant for a more distant cash flow.
- Moreover, define the information set Proof: . 8 West (1988) considers a very general framework that has a similar implication.
- Alternatively and as the authors show in this section, it can also be associated with either early disclosure of time-varying firm specific information, or disclosure of time-invariant information about firm characteristics, which may cause return synchronicity to increase.
IV. Empirical Evidence
- This section provides evidence consistent with the theory outlined above, in three different settings.
- Consistent with their univariate analysis, firm age is associated with significantly higher R2 (and thus lower LSSE), at the 1% levels, reflecting learning about the time-invariant information.
- Therefore, the authors follow Roll (1988), Piotroski and Roulstone (2004), Durnev, Morck, Yeung, and Zarowin (2003), and Durnev, Morck, and Yeung (2004) by adding industry returns in the standard market model regression.
- Inclusion of additional risk factors do not change the age effect on return synchronicity (columns (3) and (4) of Panel A in Table 2).
- One such setting is seasoned equity offerings (SEOs).
B.1. Empirical Specification
- To capture the inter-temporal response of R2 around SEOs, the authors pursue a specification that imposes very little structure on the response dynamics.
- Thus earnings smoothing would bias against their results, by raising R2 prior to ADR or SEO events.
- Hypothesis 2 derives from the second part of Proposition (1a).16 Hypothesis 1.
- That is, SEOs are not randomly assigned; there might be unobserved firm characteristics that simultaneously affect the SEO decisions and return synchronicity.
- Second, the authors include firm-fixed effects in all their estimations.
- Compared to non-SEO firm-years, SEO firm-years differ in almost all firm characteristics, suggesting that firm characteristics need to be controlled for in their later analysis.
- The impacts of other firm control variables are similar to those in Table 2.
- Then according to their Proposition 1(b) and Proposition 2, the return synchronicity may continue to be higher.
- Consistent with their model’s predictions, ADRs are associated with a persistent drop in firm specific information in stock prices (i.e., higher R2) in the years after the listings.
- 21 Specifically, the authors define countries with a score above 20 We note that some firms may cross list in countries other than the U.S.the authors.
- Existing literature has taken the perspective that if a firm’s information environment causes stock prices to reflect more firm-specific information, market factors should explain a smaller proportion of the variation in stock returns.
- The authors empirical evidence is drawn from three different settings.
- In particular, return synchronicity decreases prior to these events, and increases subsequently.
- Overall, the authors make two contributions to the literature.
- First, by showing both theoretically and empirically that stock return synchronicity can increase with improved firm transparency, the authors highlight the importance of understanding the nature of information discovery and the dynamics of response of stock return synchronicity to changes in information environment.
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Cites background from "Transparency, Price Informativeness..."
...Concerns regarding this interpretation of firm-specific idiosyncratic variance have been raised by Kelly (2007) and Dasgupta, Gan, and Gao (2009)....
...Here R 2 and β are estimated from a market model (equation (B-1)) in columns (1) and (2); from an industry-augmented market model in column (3); from the Fama and French (FF) (1993) 3-factor model and a 4-factor model with momentum (equations (B-2) and (B-3)) in columns (4) and (5)....
"Transparency, Price Informativeness..." refers background in this paper
...For share prices to reflect information, arbitrageurs need to expend resources uncovering proprietary information about the firm (Grossman (1976), Shleifer and Vishny (1997))....
"Transparency, Price Informativeness..." refers background in this paper
...5Lang and Lundholm (1996) examine the relation between firms’ disclosure policies, analyst following, and the accuracy of analysts’ forecasts....
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This paper argues that, contrary to the conventional wisdom, stock return synchronicity ( or R ) can increase when transparency improves. In a simple model, the authors show that, in more transparent environments, stock prices should be more informative about future events.