The Use of the R2 as a Measure of Firm‐Specific Information: A Cross‐Country Critique

Recent research uses the degree of stock returns co‐movement as a measure of the quality of a country's information environment. It has been argued that stronger property rights, better corporate governance regimes and more efficient enforcement mechanisms lead to prices incorporating more firm‐specific information and, therefore, co‐moving less with the market. In this paper, we use a much more comprehensive international data set than in prior research, encompassing forty countries over twenty years, to evaluate the reliability of this approach in a cross‐country setting and to analyse the behaviour of the measure used. Our results demonstrate severe limitations in the use of co‐movement as a measure of information quality. We highlight the instability of the measure and show that it can produce results that are often difficult to reconcile with such an informational explanation.