Transparency, Price Informativeness, and Stock Return Synchronicity: Theory and Evidence

What is it about?

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).

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Why is it important?

A considerable number of studies build on the premise that when a more transparent company's stock returns move less with the market returns. We show that this is incomplete at the best. When the information environment surrounding a firm improves and more firm-specific information is available, market participants are also able to improve their predictions about the occurrence of future firm-specific events. As a result, prevailing stock prices are likely to already “factor in” the likelihood of the occurrence of these events. When the events actually happen in the future, the market will not react to such news, since there is little “surprise.” In other words, more informative stock prices today should be associated with less firm-specific variation in stock prices in the future. Therefore, the return synchronicity should be higher. Our study caution against naively adopt any synchronicity measure to gauge the degree of firm transparency. We also hightlight the presence of two types of transparency: in type 1, some firm-specific informaiton is never disclosed; in type 2, firm-specific informatio is disclosed sooner or later, but a more transparent company discloses in a more timely manner. The later type is more relevant for public companies.