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Earnings Predictability, Information Asymmetry, and Market Liquidity
Author(s) -
AffleckGraves John,
Callahan Carolyn M.,
Chipalkatti Niranjan
Publication year - 2002
Publication title -
journal of accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 6.767
H-Index - 141
eISSN - 1475-679X
pISSN - 0021-8456
DOI - 10.1111/1475-679x.00062
Subject(s) - earnings , adverse selection , predictability , information asymmetry , monetary economics , cost of capital , equity (law) , business , earnings response coefficient , economics , market liquidity , ceteris paribus , financial economics , finance , microeconomics , incentive , physics , quantum mechanics , political science , law
We investigate the relation between earnings predictability, information asymmetry and the behavior of the adverse selection cost component of the bid‐ask spread around quarterly earnings announcements for NASDAQ firms. While we find an increase in the adverse selection component of the bid‐ask spread on the day of and the day prior to quarterly earnings announcements for firms with less predictable earnings, we find no evidence of such changes for firms with more predictable earnings. During a non‐announcement period, we find that firms with relatively less predictable earnings have consistently higher total bid‐ask spreads than firms with more predictable earnings. This finding suggests that firms with relatively less predictable earnings have a higher cost of equity capital than comparable firms with more predictable earning streams, ceteris paribus. Hence, earnings predictability may be a legitimate concern of managers who wish to minimize their cost of equity capital at least as it pertains to bid‐ask spreads.