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Disclosure Policy and Market Liquidity: Impact of Depth Quotes and Order Sizes *

Disclosure Policy and Market Liquidity: Impact of Depth Quotes and Order Sizes * This paper investigates the relation between disclosure policy and market liquidity. Our tests examine two key aspects of market liquidity, the effective bid‐ask spread and quoted depth, and how they relate to financial analysts' ratings of firms' disclosure policies. We introduce a method of combining order sizes and depth quotes to yield more precise estimates of effective spreads on trades likely constrained by quoted depth. We find that while firms with higher rated disclosures are charged lower effective spreads, they are also quoted lower depth, consistent with the notion that better disclosures reduce information asymmetry but also cause some liquidity suppliers to exit the market. Therefore, a simple examination of spreads and depths yields ambiguous inferences on the relation between disclosure policy and market liquidity. We resolve this ambiguity by estimating depth‐adjusted effective spreads, and find that firms with higher rated disclosures have lower depth‐adjusted effective spreads across all trade sizes. Consequently, our results reveal a robust inverse relation between disclosure ratings and effective trading costs. This implies that a policy of enhanced financial disclosure is related to improved market liquidity. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Contemporary Accounting Research Wiley

Disclosure Policy and Market Liquidity: Impact of Depth Quotes and Order Sizes *

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References (66)

Publisher
Wiley
Copyright
2005 Canadian Academic Accounting Association
ISSN
0823-9150
eISSN
1911-3846
DOI
10.1506/EETM-FALM-4KDD-9DT9
Publisher site
See Article on Publisher Site

Abstract

This paper investigates the relation between disclosure policy and market liquidity. Our tests examine two key aspects of market liquidity, the effective bid‐ask spread and quoted depth, and how they relate to financial analysts' ratings of firms' disclosure policies. We introduce a method of combining order sizes and depth quotes to yield more precise estimates of effective spreads on trades likely constrained by quoted depth. We find that while firms with higher rated disclosures are charged lower effective spreads, they are also quoted lower depth, consistent with the notion that better disclosures reduce information asymmetry but also cause some liquidity suppliers to exit the market. Therefore, a simple examination of spreads and depths yields ambiguous inferences on the relation between disclosure policy and market liquidity. We resolve this ambiguity by estimating depth‐adjusted effective spreads, and find that firms with higher rated disclosures have lower depth‐adjusted effective spreads across all trade sizes. Consequently, our results reveal a robust inverse relation between disclosure ratings and effective trading costs. This implies that a policy of enhanced financial disclosure is related to improved market liquidity.

Journal

Contemporary Accounting Research – Wiley

Published: Dec 1, 2005

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