Financial Transparency and Stock Returns: An International Study

This study analyses the relationship between financial transparency and price informativeness with respect to forward earnings for a sample of European firms. Price informativeness is defined in the context of the amount of information reflected in current returns about future and current earnings. Prices are said to be more informative if they reflect not only current accounting earnings but also the implications of accrual accounting for future earnings. On the other hand, when the lack of disclosure does not allow market participants to conduct fully informed valuations, prices might be prone to volatility due to the subsequent revelation of implications of accrual accounting. This paper shows that the effect of disclosure on price informativeness is conditional upon the firm level timeliness and transparency of accounting earnings. That is, increasing disclosure does not necessarily increase price informativeness if accounting numbers are already transparent. However, role of disclosure is more important when earnings are less transparent and contain transitory items. On the other hand, firms with more timely earnings do have informative prices and even more so if they are good disclosers. The hypotheses are supported by testing price informativeness in the presence of a detailed set of indicators based on Standard and Poor’s Transparency and Disclosure rankings, using the panel data analysis. The model is estimated by means of a feasible generalized least squares regression controlling for extreme observations employing the multivariate procedure by Hadi (1992, 1994).