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    Does Earnings Quality Affect Information Asymmetry? Evidence...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 08.0 Auditing Procedures – Nature, Timing and Extent, 08.05 Evaluating Accruals/Detection of Abnormal Accruals, 14.0 Corporate Matters, 14.05 Earnings Targets and Management Behavior 
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    Title:
    Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs
    Practical Implications:

    The quality of reported in earnings is influenced by a firm’s fundamentals. To the extent investors differ in their ability to process this information, poor earnings quality can lead to information asymmetry, which can be costly. For these reasons, standard-setters and regulators are concerned about the quality of accounting information and its consequences for capital markets. This study provides empirical support for the concerns articulated by regulators that an important adverse consequence of poor earnings quality is increased information asymmetry and reduced liquidity.

    For more information on this study, please contact Nilabhra Bhattacharya.
     

    Citation:

    Bhattacharya, N., H. Desai, and K. Venkataraman. 2013. Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs. Contemporary Accounting Research 30 (2).

    Keywords:
    financial reporting; earnings quality; information asymmetry
    Purpose of the Study:

    An important attribute of the quality of accounting information is the extent to which earnings (accruals) map into cash flows. Poor mapping of accruals into cash flows reduces the information content of reported earnings and results in lower-quality earnings. If investors differ in their ability to process earnings related information, then poor earnings quality can result in differently informed investors and thereby exacerbate the information asymmetry in financial markets. Regulators and standard-setters view a reduction in information asymmetry to be an important benefit of improved earnings quality. This study examines whether poor earnings quality is associated with higher information asymmetry in capital markets.

    Design/Method/ Approach:

    The authors examined the association between earnings quality and information asymmetry during non-earnings announcement periods. Additionally, they tested whether earnings quality is associated with the increase in adverse selection risk around earnings release. The initial sample of firms tested included all NSYE and NASDAQ firms with available data on the CRSP, COMPUSTAT, and Trades and Quotes (TAQ) databases. The firm data was measured for the years 1997 through 2006. Information asymmetry was measured as reflected in the adverse selection component of the trading cost.  Descriptive statistics were used to gather empirical results.

    Findings:
    • The inverse relation between earnings quality and the increase in information asymmetry around earnings releases is observed for all measures of earnings quality.
    • The association between earnings quality and the increase in information asymmetry is more pronounced for smaller firms.
    • Managerial choices that cause accruals volatility to be too high or too low relative to industry norms increase information asymmetry.
       
    Category:
    Auditing Procedures - Nature - Timing and Extent, Corporate Matters
    Sub-category:
    Earnings Targets & Management Behavior, Evaluating Accruals/Detection of Abnormal Accruals