A common argument for mandatory disclosure is that it reduces information asymmetry by converting private information to public information. Disclosure requirements mandated by the regulatory authority ensure the firm to produce firm-specific information otherwise searched by intermediaries. The release of the firm-specific information reduces the information asymmetry among market participants. If such firm-specific information is not disclosed but kept as private information, those who spend resources to obtain the information are compensated. If the cost of information generation is an increasing function, then mandatory disclosure increases the intermediaries’ marginal cost of information.
Therefore, mandatory disclosure is likely to reduce information asymmetry between informed and uninformed. Furthermore, theoretical work by Diamond and Verrecchia (1991) show that increased disclosure reduces trading cost, thus the liquidity of stock increases. This has been shown empirically by Leuz and Verrecchia (2000), Healy, Hutton, and Palepu (1999), and Heflin, Shaw, and Wild (2005). Therefore, the effect of increased disclosure is a more informative stock price and a more liquid stock market.
On the other hand, each financial reporting or earning announcement is an information event. If intermediaries spend resources to gather private information before earning announcement, they realize the gain after the private information is made public. With the higher number of information event, the intermediaries have more opportunity to realize the gain from their information advantage. Therefore, the information asymmetry among market participants may increase. Amihud and Mendelson (1986) point out that higher information asymmetry leads to higher bid-ask spread; and the investor requires higher rate of return to compensate for the high trading cost. The final result is lower firm value and less liquid stock. With the two contradicting propositions in mind, the effect of increased reporting frequency on stock price informativeness and liquidity is ambiguous.
Our next research question is whether there exists differential response to financial reporting frequency across developed and emerging markets. It is common to obtain different effect for a similar policy implementation across developed and emerging markets. In a recent study, Fernandes and Ferreira (2008) document the enforcement of insider trading law turns private information into public information only in developed markets. We are curious about the increase of same disclosure level brings different response across countries. In our study, we use financial reporting frequency as a measure of mandatory financial disclosure level.
We choose reporting frequency because it is a regular and formal channel to disseminate material information to market participant. More importantly, it has cross-country variation as well as time series variation. The most common reporting frequencies are quarterly reporting (US, Canada) and semiannually reporting (UK, Australia). Over the time, significant amount of countries increase their mandated financial reporting frequency, mostly from semiannual to quarter frequency.
