Stock Return Synchronicity and the Informativeness of. Stock Prices: Theory and Evidence 1

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1 Sock Reurn Synchroniciy and he Informaiveness of Sock Prices: Theory and Evidence Sudipo Dasgupa Jie Gan + Ning Gao # JEL Classificaion Code: G4, G39 Keywords: Sock reurn synchroniciy; R 2 ; Firm-specific reurn variaion; Informaiveness of sock prices; Transparency; Seasoned equiy offering; Cross lising. We hank Upal Bhaacharya, Michael Brennan, Kalok Chan, Craig Doidge, Ar Durnev, Rober Engle, Li Jin, Erns Maug, Sewar Myers, Wei Jiang, Anil Makhija, Bill Megginson, Randall Morck, Mark Seasholes, Jeremy Sein, Marin Walker, Bernard Yeung and paricipans a he 26 Financial Inermediaion Research Sociey Conference and he 26 WFA Conference for helpful commens and discussions. We are graeful o Hendrik Bessembinder (he edior) and wo anonymous referees for heir commens and suggesions which grealy improved he paper. Deparmen of Finance, Hong Kong Universiy of Science and Technology, Clear Waer Bay, Kowloon, Hong Kong. dasgupa@us.hk. + Deparmen of Finance, Hong Kong Universiy of Science and Technology, Clear Waer Bay, Kowloon, Hong Kong. jgan@us.hk. # The Mancheser Accouning and Finance Group, Mancheser Business School, he Universiy of Mancheser, Booh Sree Wes, Mancheser, M5 6PB, Unied Kingdom. ning.gao@mbs.ac.uk.

2 Sock Reurn Synchroniciy and Informaiveness of Sock Prices: Theory and Evidence Absrac This paper argues ha, conrary o he convenional wisdom, sock reurn synchroniciy (or R 2 ) can increase when ransparency improves. In a simple model, we show ha, in more ransparen environmens, sock prices should be more informaive abou fuure evens. Consequenly, when he evens acually happen in he fuure, here should be less surprise, i.e., here is less new informaion impounded ino he sock price. Thus a more informaive sock price oday means higher reurn synchroniciy in he fuure. We find empirical suppor for our heoreical predicions in hree seings, namely firm age, seasoned equiy issues, and lising of ADRs. JEL Classificaion Code: G4, G39 Keywords: Sock reurn synchroniciy; R 2 ; Firm-specific reurn variaion; Informaiveness of sock prices; Transparency; Seasoned equiy offering; Cross lising. 2

3 I. Inroducion Financial economiss generally agree ha in efficien markes, sock prices change o reflec available informaion eiher firm-specific or marke-wide. Recen lieraure has addressed he quesion of how a firm s informaion environmen (disclosure policy, analys following) or is insiuional environmen (propery righs proecion, qualiy of governmen, legal origin) can affec he relaive imporance of firm-specific as opposed o marke wide facors (Jin and Myers (26), Pioroski and Roulsone (23), Chan and Hameed (26), and Morck, Yeung, and Yu (2)). This lieraure has aken he perspecive ha if he firm s environmen causes sock prices o aggregae more firm-specific informaion, marke facors should explain a smaller proporion of he variaion in sock reurns. In oher words, he sock reurn synchroniciy or R 2 from a sandard marke model regression should be lower. This perspecive, while inuiive, is a odds wih anoher equally inuiive implicaion of marke efficiency. In efficien markes, sock prices respond only o announcemens ha are no already anicipaed by he marke. When he informaion environmen surrounding a firm improves and more firm-specific informaion is available, marke paricipans are also able o improve heir predicions abou he occurrence of fuure firm-specific evens. As a resul, prevailing sock prices are likely o already facor in he likelihood of occurrence of hese evens. When he evens acually happen in he fuure, he marke will no reac o such news, since here is lile surprise. In oher words, more informaive sock prices oday should be associaed wih less firm-specific variaion in sock prices in he fuure. Therefore, he reurn synchroniciy should be higher. In his paper, we presen a simple model o illusrae he poin ha a more ransparen informaion environmen can lead o higher, raher han lower, sock reurn synchroniciy. This is 3

4 because, for a more ransparen firm, here is already more informaion available o marke paricipans, reducing he surprise from fuure announcemens. In our model, we disinguish beween wo ypes of firm-specific informaion. One perains o ime-varying firm characerisics, reflecing he curren sae of he firm, such as nex quarer s earnings. The oher is ime-invarian, such as managerial qualiy. 2 Sock reurn synchroniciy can increase subsequen o an improvemen in ransparency hrough disclosure of boh ypes of informaion. Firs, greaer ransparency can lead o early disclosure of ime-varian informaion. This can happen around major evens such as seasoned equiy issues (SEOs) or cross-lisings, during which a big chunk of informaion abou fuure evens is revealed. Thus when fuure evens acually happen, here is less surprise and hence less addiional informaion o be incorporaed in he sock price, resuling in a higher reurn synchroniciy. 3 While he posiive effec of greaer ransparency on reurn synchroniciy is mos significan in he case of a one-ime lumpy disclosure, we show ha i also holds in he more general seing wih regular, early disclosure of informaion. In paricular, we show ha in a dynamic seing, if a he beginning of every period, ousiders ge o know (one period ahead of ime) some of he informaion ha oherwise would come ou a he end of he period, he reurn synchroniciy is acually higher. The second channel hrough which greaer ransparency increases sock reurn synchroniciy is due o learning abou ime-invarian firm-specific characerisics, such as managerial qualiy. In paricular, beer disclosure allows marke paricipans o learn abou imeinvarian firm fundamenals wih greaer precision (e.g., in he exreme case where he 2 Sricly speaking all firm characerisics are ime varying in he very long run. Here we refer o hose characerisics ha do no change frequenly or do no change much over ime (so ha hey do no affec valuaion significanly) as ime-invarian. 3 Shiller (98) noes heoreically ha if dividend news arrives in a lumpy and infrequen way, sock price volailiy becomes lower. If much of he dividend news reflecs firm specific informaion, one would also expec reurn synchroniciy o become higher. 4

5 fundamens are compleely known, here is no new learning). Therefore, wih more disclosure, he priors abou hese fundamenals will be revised less drasically as new informaion comes in. As a resul, here will be less firm-specific variaion in sock prices, i.e., he reurn synchroniciy will be higher. We presen hree pieces of empirical evidence consisen wih our model s predicions. We firs provide evidence of learning abou ime-invarian firm-specific informaion. The idea is ha, as a firm becomes older, he marke learns more abou is ime-invarian characerisics, e.g., he firm s inrinsic qualiy. Therefore, reurn synchroniciy should be higher for older firms, since more of he (ime-invarian) firm-specific informaion is already refleced in he sock price. This predicion is srongly suppored by he daa. Second and hird, we exploi he fac ha he effec of greaer ransparency on sock reurn synchroniciy is likely o be especially clear when he disclosure is lumpy, in he sense ha he marke receives a big chunk of informaion relevan for fuure cash flows. Therefore, we focus on seasoned equiy offerings (SEOs) and cross-lisings in he U.S. 4 I is well known ha boh evens are associaed wih significan amouns of informaion disclosure and marke scruiny (see, e.g., Almazan e al. (22) for SEO, and Lang e al. (23) for ADR lisings). Our model suggess a dynamic response of reurn synchroniciy o an improvemen in he informaion environmen. A he ime when new informaion is disclosed and impounded ino sock prices, he firm-specific reurn variaion will increase, as suggesed by convenional wisdom. However, since a big chunk of relevan informaion is already refleced in sock prices, we would expec he firm-specific reurn variaion of SEO and cross-lised firms o be subsequenly lower. This dynamic response of he firm-specific reurn variaion around seasoned equiy issues and cross- 4 While firms can lis heir shares in he U.S. exchanges eiher hrough ADRs or hrough direc lisings, he lieraure someimes uses he wo erms cross lisings and ADR lisings inerchangeably (see, e.g., Lang, Lins, and Miller (23)). In he res of his paper, we follow his convenion, excep when we discuss our sample. 5

6 lising evens is he main focus of our empirical exercise and we find srong suppor for i in he daa. 5 Overall, in his paper, we make wo conribuions o he lieraure. Firs, we address he lieraure on ransparency, informaiveness of sock prices, and sock reurn synchroniciy by arguing ha a more ransparen firm can have a higher reurn synchroniciy, conrary o he convenional wisdom. Therefore, our paper highlighs ha i is imporan o undersand he naure of informaion disclosure in rying o inerpre any paricular associaion (or is absence) beween ransparency and sock reurn synchroniciy. Second, we add o he growing lieraure on informaion disclosure around securiy issuance evens such as SEOs or ADRs by showing ha sock price synchroniciy changes in a way ha is consisen wih lumpy informaion disclosure associaed wih hese evens. The res of he paper is organized as follows. Secion II reviews relaed lieraure. Secion III presens he model. Secion IV repors he empirical findings and Secion V concludes. II. Relaed Lieraure A. Sock Reurn Synchroniciy (R 2 ) A recen lieraure has documened a link beween he synchroniciy of sock reurns and he informaiveness of sock prices a he counry level. Morck, Yeung, and Yu (2) (MYY (2) hereafer) firs repor ha, in economies where propery righs are no well proeced, synchroniciy of sock reurns measured by a marke model R 2 is significanly higher. The auhors argue ha weaker propery righs discourage informed arbirage aciviy based on privae informaion, and sock prices are driven more by poliical evens and rumors. In a recen paper, 5 A common concern abou he empirical idenificaion of he SEO/ADR effecs is he poenial self-selecion of SEO and ADR lisings. We discuss laer how our empirical specificaion addresses his issue. 6

7 Jin and Myers (26) examine he link beween measures of corporae ransparency and reurn synchroniciy. They argue ha in a more ransparen environmen, proporionaely more firmspecific informaion is revealed o ouside invesors. As a resul, marke-wide informaion explains a smaller proporion of he overall reurn variaion, resuling in a lower reurn synchroniciy. Ohers have invesigaed wheher resuls a he counry level carry over o he firm level. They find mixed resuls. On he one hand, Durnev, Morck, Yeung, and Zarowin (23) find ha higher firm-specific sock price variaion is associaed wih higher informaion conen abou fuure earnings. On he oher hand, Pioroski and Roulsone (24) find ha reurn synchroniciy increases wih analys coverage. They inerpre his as evidence ha analyss specialize by indusry, and, as a resul of greaer analys coverage, more indusry-wide and marke-wide informaion ges impounded in sock prices. Using daa from emerging markes, Chan and Hameed (26) repor ha greaer analys coverage increases reurn synchroniciy. Barberis e al. (25) find ha inclusion in (deleion from) he S&P 5 index, which presumably increases (decreases) firm-level ransparency, increases (decreases) a sock s reurn synchroniciy. Given hese inconsisencies, i is useful o review he deerminans of he marke model reurn synchroniciy. Consider a simple regression of firm reurn on marke reurn. In his case, R = SSR/SST = β S / ( β S + SSE). Thus, an increase in reurn synchroniciy can come from xx xx hree sources: () an increase in marke-wide reurn variaion (Sxx), ceeris paribus; (2) a decrease in he idiosyncraic reurn variaion (SSE), ceeris paribus; (3) an increase in bea (β), or he sock s co-movemen wih he marke, ceeris paribus. The resuls in MYY (2) for counrylevel R 2 could be primarily aribuable o higher marke-wide reurn volailiy associaed wih weaker propery righs proecion (which discourages informaion acquisiion and creaes more 7

8 space for noise rading); hose in Jin and Myers (26) are aribuable o lower idiosyncraic reurn variaion in counries wih poor ransparency. Noe ha a he counry level, as he aggregaed bea is exacly by definiion, he counry level sudies have generally associaed a lower average R 2 wih eiher a higher firmspecific reurn variaion, or lower aggregae marke volailiy. This, however, is no he case a he firm level. The mixed resuls on R 2 a he firm level can be reconciled by his bea effec: S&P addiions (Barberis e al. (25)) or more analys coverage (Pioroski and Roulsone (24), Chan and Hameed (26)) lead o an increased co-movemen wih marke and hus he bea. Barberis e al. (25), for example, argue ha when making porfolio decisions, invesors group asses ino caegories (such as small-cap socks, value socks), and allocae funds a he level of hese caegories. Addiions ino he S&P 5 may move he sock ino a caegory wih more populariy wih invesors, wih a resulan increase in bea and R 2. Likewise, as analyss help o impound more marke-wide informaion ino he sock price, he sock reurn exhibis higher comovemen wih he marke, resuling in higher bea and reurn synchroniciy. This highlighs a need o conrol for he bea effec in firm-level sudies of R 2 when one is primarily ineresed in how he informaion environmen affecs he idiosyncraic reurn variaion. B. Informaion Revelaion and he Informaiveness of Sock Prices The idea ha a more ransparen firm has sock prices ha are more informaive abou fuure evens is no new. Fishman and Hagery (989), for example, presen a model in which firm disclosure increases he informaiveness of sock prices abou fuure cash flows, which in urn enhance he resource allocaion efficiency. Gelb and Zarowin (22) empirically find ha beer disclosure policies are associaed wih sock prices ha are more informaive abou fuure 8

9 earnings changes. 6 In an ineresing paper, Bhaacharya e al. (2) find ha shares in he Mexican Sock Exchange reac very lile o he announcemen of company news. This is no because firms lised in he sock exchange in Mexico are more ransparen, bu raher because, due o insider rading, he superior informaion of insiders is already incorporaed in sock prices, so here is lile surprise on announcemen. Several recen papers have made an associaion beween he informaiveness of sock prices as measured by sock reurn synchroniciy and he efficiency of resource allocaion. For example, Durnev, Morck, and Yeung (24) and Wurgler (2) find ha higher firm-specific reurn variaion enhances invesmen efficiency. Chen, Goldsein, and Jiang (24) use reurn synchroniciy as a measure of privae informaion incorporaed in he sock prices and find ha invesmen responds more o sock prices when he sock reurn synchroniciy is lower. Similar o our view, hey noe ha invesmen does no necessarily respond more srongly o informaion if he manager was already knowledgeable abou he informaion (and hence has already aken he relevan acion). Wha moves invesmen-price sensiiviy is he informaion ha ges ino price hrough rading by he privae speculaors (who know somehing ha he manager does no). III. Disclosure, Transparency and Sock Reurn Synchroniciy: Theory 6 Lang and Lundholm (996) examine he relaion beween firms disclosure policies, analys following, and he accuracy of analyss forecass. They find ha wihin a paricular indusry, firms ha are more forhcoming in heir disclosure policies have larger analys following, more accurae analys earning forecass, less dispersion abou individual analys forecass, and less volailiy of forecas revisions. While hey do no direcly address he issue of informaiveness of sock prices, heir resuls sugges ha fuure oucomes are easier o predic when firms are more ransparen. 9

10 In his secion, we presen he argumens abou how new disclosure and improvemen in ransparency affec reurn synchroniciy. To faciliae comparison, we frame he argumens in he conex of a model developed in a recen paper by Jin and Myers (26). As in Jin and Myers (26), we assume ha he firm s cash flow generaing process is, () C = KX where K is iniial invesmen, and X is he sum of hree independen shocks o he firm s cash flow: (2) θ, θ 2, X = f + +. Here, f capures marke facors ha are observed by all; θ, and θ2, are firm-specific shocks. Ousiders only observeθ,, whereas insiders observe boh θ, andθ 2,. As in Jin and Myers (26), we assume ha f, θ, and θ 2, are all saionary AR() processes wih he same AR() parameer φ, where > φ > : (3) f+ = f + φ f + ε + (4) θ, + = θ, + φθ, + ξ, + and

11 (5) θ2, + θ2, φθ2, ξ2, + = + +. Le κ θ, θ2, = Var( + ) / Var( f ) denoe he raio of firm-specific o marke variance in cash flows. Also following Jin and Myers (26), le η = Var( θ, ) / [Var( θ, ) + Var( θ2, )], he proporion of he variance of he firm-specific componen ha is due o he par ha is observable o he ousiders. A higherη is associaed wih beer firm ransparency. The inrinsic value of he firm from he poin of view of invesors a any poin of ime is he presen value of fuure cash flows condiional on heir informaion se I : (6) K I ) = PV{ E( C I ), E( C I ),..., } ( r where he discouning is done a he risk-free rae r. Ouside shareholders can seize conrol of he firm hrough collecive acion and manage he firm on heir own. The value of he firm under he ousider shareholders managemen is α whereα <. This ses he ex-dividend marke value of he firm (i.e. is value o ouside K invesors) a ex (7) V ( I ) = α K ( I ).

12 ex ex We have V ( I ) = [ E( Y I ) + E( V I )]/( + r), where Y+ is he dividend a +. Jin and + + Myers (26) show (Jin and Myers (26), Proposiion 3) ha he equilibrium dividend is a consan fracion α of he invesor condiional expecaion of cash flow: (8) * τ Y = αe( Cτ I ) τ. We now depar from Jin and Myers (26) by assuming ha here is a change in he firm s disclosure policy and he firm becomes more ransparen. Specifically, we consider wo differen ypes of changes in disclosure policy: one is relaed o ime-varian firm-specific informaion; he oher concerns ime-invarian informaion abou firm characerisics. A. Disclosure of Time-Varian Informaion A.. Lumpy (One-Time) Informaion Disclosure During SEOs or ADR lisings, he firm becomes more ransparen in he sense ha a big chunk of informaion comes ou ha oherwise would have come ou laer, or perhaps no a all. To model his ype of disclosure, we assume ha he marke learns, a ime, of + δ where (9.) a) ξ = ξ + δ ', +, + + 2

13 ' (9.2) b) E ξ, δ ). ( + + = The inerpreaion is as follows. Equaions (9.) and (9.2) imply ha he marke learns one period ahead of ime some informaion ha is relevan for he + cash flow innovaion. We call his informaion disclosure lumpy because his is a one-ime early disclosure of informaion ha reduces he variance of he cash flow shock a +, so ha he quanum of informaion revealed a exceeds ha a any oher subsequen poin of ime. A major even such as he lising of ADRs is likely o be associaed wih revelaion of informaion relevan for firm-specific evens ha could affec fuure cash flows. This informaion, however, should be less relevan for evens ha occur furher ino he fuure. For simpliciy of exposiion, we make he exreme assumpion ha he informaion revealed a disclosure affecs only he cash flow shock one period laer, i.e. i is relevan for evens ha occur one period laer only. Denoe σ = Var( ξ ) / Var( ξ ) <. ', +, + This parameer measures how much informaion is revealed early regarding he cash flow shock one period laer he lower is σ, he less is he residual uncerainy regarding he innovaion ha is revealed a +, i.e., he greaer is he informaion conen of he disclosure a. We are now ready o compare he effec of he change in disclosure policy a on sock reurn synchroniciy. Proposiion (a). 3

14 (i) The proporion of he realized variaion in period (i.e. beween and ) explained by marke facors is higher for a firm ha experience an improvemen in disclosure a han one ha does no. (ii) The proporion of realized variaion explained by marke facors for period is less for a firm ha experiences an improvemen in disclosure policy han one ha does no. + Proof: (Appendix A) Lumpy informaion disclosure consiss of a one-ime early disclosure of new informaion ha oherwise would have been revealed laer. When he informaion is revealed and impounded ino sock prices, he reurn synchroniciy will decrease. However, he reurn synchroniciy will increase subsequenly here is less informaion conen o laer announcemens since par of he informaion is already impounded in he sock price. A.2. Regular Early Disclosure of Informaion One noion of ransparency is simply ha news is announced in a imely manner, so ha he surprise componen from fuure evens is lower. To formalize his noion of ransparency, we assume ha a he beginning of every period, here is some disclosure ha reduces he variance of he cash flow shock revealed o he public a he end of he period. More formally, we assume ' (.) a) ξ, + = ξ, + + δ + for all 4

15 (.2) b) ' E( ξ + δ + ) =. and (.3) c) ' Var( ξ+ ) = σ <. Var( ξ ) + We hen have he following: Proposiion (b). Suppose he risk-free rae is sricly posiive, and he ransparency improves in he sense ha every period, some δ + is revealed o ousiders, where δ + saisfies equaions (.) - (.3). Then he sock reurn synchroniciy every period is sricly higher han ha of an oherwise idenical firm ha does no experience an improvemen in ransparency. Proof: (Appendix A). The resul ha he reurn synchroniciy acually increases in his case may be somewha surprising. Each period, some of he informaion affecing he cash flow innovaion is disclosed early and reduces he subsequen surprise ; however, a new piece of informaion relevan for he cash flow innovaion sill one period laer is revealed a he end of he period. Why do hese wo effecs no wash each oher ou compleely? The reason is ha he informaion revealed a he end of he period regarding he cash flow innovaion sill one period laer is discouned relaive o he informaion revealed a he beginning of he period, since he former is relevan for a more disan cash flow. Thus, he reurn synchroniciy is higher. 7 7 See Peng and Xiong (26, p.577), for a very similar resul illusraing he effec of early arrival of informaion and discouning. 5

16 B. Disclosure of Time-invarian Informaion abou Firm Characerisics We nex show ha disclosure ha conveys informaion abou ime-invarian firm characerisics such as managerial abiliy can also raise reurn synchroniciy. The inuiion is ha if managerial abiliy has o be inferred for example, on he basis of observable cash flows hen he value of he firm will flucuae more due o observable cash flow shocks, compared o a siuaion where managerial qualiy is already known o he marke on accoun of greaer ransparency and disclosure. Consequenly, he proporion of he overall variaion in reurns ha is explained by marke facors will be lower for a less ransparen firm. 8 Unlike he case of a oneime early disclosure of informaion ha would have come ou laer, he effec of his ype of disclosure on reurn synchroniciy is likely o be more durable. To formally demonsrae how he reurn synchroniciy can increase, assume ha θ, in equaion (4) represens some firm-specific characerisic (such as managerial qualiy). The rue value of θ, is no known o he marke, which only knows ha i is drawn from some disribuion. Moreover, define he informaion se I o include he enire hisory of he realizaions of (f, θ, ). We he have he following: Proposiion 2. Fix a hisory ( f ) θ up o ime. The proporion of he realized,, : variaion explained by he marke facor in period will be higher if θ, is revealed o he marke a any ime prior o han if i is no. Proof: (Appendix A). 8 Wes (988) considers a very general framework ha has a similar implicaion. Suppose ha I and I 2 are wo informaion ses and I is a subse of I 2. Wes shows ha he forecas of he presen discouned value of dividends will be revised more ofen if he forecas is made on he basis of I raher han I 2. 6

17 To summarize, he naure of disclosure associaed wih an improvemen in ransparency can ake differen forms. As in Jin and Myers (26), i can ake he form of more firm-specific informaion being revealed o ousiders on a regular basis, in which case he reurn synchroniciy will decrease. Alernaively and as we show in his secion, i can also be associaed wih eiher early disclosure of ime-varying firm specific informaion, or disclosure of ime-invarian informaion abou firm characerisics, which may cause reurn synchroniciy o increase. In paricular, for lumpy informaion disclosure, reurn synchroniciy will firs decrease when new informaion is impounded in sock prices, bu increase subsequenly. This dynamic behavior of reurn synchroniciy around lumpy disclosure evens is wha we aemp o capure in our empirical analysis in he subsequen secion. IV. Empirical Evidence This secion provides evidence consisen wih he heory oulined above, in hree differen seings. The firs explores he effec of variaion in he informaion environmen as proxied by firm age. The oher wo correspond o discree changes in he informaion environmen due o seasoned equiy offerings and cross lisings. Since he heory is abou reurn variaion ha can be explained by he marke facors (holding oal reurn variaion consan), in our empirical exercises we (inversely) measure sock reurn synchroniciy using log(- R 2 ). The advanage of his measure is ha i is equivalen o firm-specific reurn variaion or he log of Sum of Squares of Errors (SSE) (LSSE hereafer) 7

18 when log of oal reurn variaion (SST) is conrolled for. 9 Resuls based on R 2 as a measure of reurn synchroniciy are qualiaively he same and are no repored for breviy. A. Sock Reurn Synchroniciy and Firm Age We now examine he relaion beween R 2 and firm age o provide evidence of learning abou ime-invarian firm-specific informaion. As a firm becomes older, he marke learns more abou ime-invarian firm characerisics, e.g., he firm s inrinsic qualiy. Thus sock reurn synchroniciy should be higher for older firms. We firs examine he relaion beween R 2 and firm age by esimaing he following basic model: () 2 log( R ) i, = α + βagei, + γfirm Conrols i, + ηi+ δ+ε i,, where i indexes firms and indexes years. The dependen variable is based on R 2 esimaed from a marke model (see Appendix B for deails), and, as discussed earlier, is equivalen o firm specific reurn variaion (LSSE). Age is he firm age since IPO. Firm Conrols include hose commonly used in he lieraure, namely, firm size (defined as he naural logarihm of asses), Marke-o-book (defined as he raio of marke value of equiy plus he book value of deb over oal asses), leverage (defined as book value of long-erm deb over oal asses), reurn on asses (defined as operaing income before depreciaion over oal asses), as well as bea. η i are firm fixed effecs which conrols for ime-invarian unobserved firm characerisics. δ are year fixed effecs which conrol for macro economic changes. In all regressions, we conrol for he log of 9 This comes from a direc ransformaion from R 2 (a raio variable) o SSE (a level variable). In paricular, log (- R 2 ) = log(sse) log (SST), where SST is oal variaion. 8

19 he oal variaion of he firm s sock reurn. Since informaion disclosed during IPO can sill affec R 2 in he years immediaely afer he IPO year, we require ha firm-years in our sample are a leas hree years afer he IPO year. Table presens he summary saisics of he main variables. Consisen wih learning abou ime-invarian informaion, older firms end o have significanly higher R 2 (lower LSSE) han do younger firms, boh in erms of he mean and he median (significan a he % levels). Older firms end o be bigger, more leveraged, and more profiable. They have lower bea and lower Q. [Inser Table here] The regression resuls are repored in column () in Panel A of Table 2. Consisen wih our univariae analysis, firm age is associaed wih significanly higher R 2 (and hus lower LSSE), a he % levels, reflecing learning abou he ime-invarian informaion. Marke-obook and leverage have negaive (posiive) effecs on R 2 (LSSE), whereas higher bea, larger size and higher profiabiliy increases R 2 a he % level. [Inser Table 2 here] One poenial alernaive explanaion of our resuls is ha he sandard marke model is no he correc asse pricing model for firm-level reurns. For example, our measure of R 2 does no include indusry-wide reurn variaion. Thus i is possible ha our age effec is driven by a ime-varying indusry effec. Therefore, we follow Roll (988), Pioroski and Roulsone (24), Durnev, Morck, Yeung, and Zarowin (23), and Durnev, Morck, and Yeung (24) by adding 9

20 indusry reurns in he sandard marke model regression. The resuls remain qualiaively unchanged (column (2) in Panel A of Table 2). To furher address he concern ha our age effecs are simply picking up missing risk facors, we esimae R 2 based on Fama-French hree-facor model and a four-facor (including momenum) model and include he firm-specific facor loadings as independen variables in our regressions (see Appendix B for deails on he consrucion of hese variables). Inclusion of addiional risk facors do no change he age effec on reurn synchroniciy (columns (3) and (4) of Panel A in Table 2). Anoher alernaive inerpreaion of he age effec is ha firm fundamenals are more sable and, herefore, co-move more for older companies. Indeed, if he fundamenals of older firms co-move more eiher wih marke or indusry, hen one would observe a higher R 2 even wihou learning. We hus follow MYY (2) and Durnev e al. (24) o conrol for ROA co-movemen wihin hree-digi SIC code (see Appendix B for deails). The coefficien on idiosyncraic ROA movemen is significanly posiive, consisen wih he conjecure ha wih greaer fundamenals co-movemens, sock prices also ends o co-move more (columns (5)-(8) in Panel A of Table 2). However, our age effecs remain unchanged. In Panel B of Table 2, we examine wheher some addiional firm characerisics, oher han hose commonly used in he lieraure, migh drive he age effec. One such firm characerisic is diversificaion. Older firms end o be larger and more diversified secorally. Thus hey are more like porfolios and i is well known ha diversified porfolios are much more correlaed han individual socks wih broad marke indices. Indeed as shown in columns ()-(4) in Panel B of Table, diversified firms are older and end o have lower firm-specific reurn volailiy (boh differences significan a he % level). To ensure ha we do no simply pick up a diversificaion effec, we conrol for wheher or no he firms has muliple segmens as repored 2

21 in COMPUSTAT. As shown in columns ()-(4) in Panel B of Table 2, Diversificaion is significanly associaed wih higher R 2 or low LSSE (a he 5% level). However, diversificaion does no drive ou our age effec. 2 Finally, since diversified firms end o be more maure and sable, we furher add idiosyncraic ROA movemen in he esimaion (columns (5)-(8) of Panel B in Table 2). Our age effecs remain qualiaively unchanged. Boh diversificaion and idiosyncraic ROA movemen effecs are significan, suggesing ha hey each have independen influence on reurn synchroniciy. In addiion o our analysis of he age effec on reurn synchroniciy, here is evidence ha he informaion conen of news announcemens is lower for older firms. Dubinsky and Johannes (26) develop a numerical mehod o exrac a measure of he surprise conen from he earnings announcemens using opions-implied earnings jump volailiy. In paricular, wo opions expiring righ before and afer he announcemen daes are used. From he implied volailiy of boh opions one can back ou he volailiy aribuable o he jump on earnings announcemen. Based on a sample of firms ha have liquid opion rading for , one can regress opion-implied earnings jump volailiy on age and a se of conrols. As ploed in Figure, he opion implied earnings jump volailiy is srongly (negaively) relaed o firm age, implying ha he new informaion conen is larger for younger firms. 3 [Inser Figure here] The resuls are robus o some oher sandard diversificaion measures in he lieraure, including he number of segmens and Hirfindahl indices based on segmen sales and asses, boh in erms of he signs of coefficien esimaes and heir saisical significance (unrepored). We noe ha adding he diversificaion measure resuls in a reduced sample size. This is because our iniial sample sars from 976, whereas COMPUSTAT segmen informaion is available only afer When we include an ineracion erm beween diversificaion and age, his ineracion is no significan, suggesing ha he age effec does no vary across diversified and single-segmen firms. In he ineres of breviy, his resul is no repored bu is available upon reques. 3 We hank Wei Jiang and Mike Johannes for providing us he char based on heir projec ha analyzes he informaion propery of he Dubinsky and Johaness (26) measure. 2

22 B. Sock Reurn Synchroniciy (R 2 ) and Seasoned Equiy Offerings (SEOs) As discussed earlier, our poin abou he dynamic effec of he informaion environmen on reurn synchroniciy is bes illusraed in cases where he informaion disclosure is lumpy. One such seing is seasoned equiy offerings (SEOs). SEOs are infrequen evens ha arac marke aenion and scruiny, resuling in disclosure of a subsanial chunk of new informaion. Mos U.S. equiy issuers choose a radiional marke offering as a mehod of issuing seasoned equiy. 4 Typically, he issuer goes hrough a process of book building and road shows much as in an iniial public offering. During he road show, he issuing firm explains o poenial invesors he changes in he company for example, why i is raising funds now and hus reveals considerable new firm-specific informaion. 5 In addiion, underwriers are likely o produce informaion as par of heir due diligence. The informaion may also be generaed by new invesors if he process of equiy issuance emporarily makes he sock more liquid. B.. Empirical Specificaion To capure he iner-emporal response of R 2 around SEOs, we pursue a specificaion ha imposes very lile srucure on he response dynamics. Specifically, we include dummy variables for he year of SEO, for and 2 years afer SEO, as well as for he years immediaely prior o SEO. These variables should idenify he response funcion of R 2 o he passage of ime around 4 In he U.S., especially afer 997, many issuers can now also choose o do acceleraed offerings raher han radiional markeed offerings. These include acceleraed book building (where hey only do a one or wo day road show or, more ofen, jus a conference call he day before he offering) and block rades, which are similar o sealed bid aucions. However, he radiional mehod is almos always followed for large offerings. 5 A he ime of informaion revelaion, i is also possible managers may have incenives o increase earnings before and around he ime of securiies issues (Teoh, Welch, and Wong (998a) and (998b)), which may reduce firmspecific reurn volailiy. Thus earnings smoohing would bias agains our resuls, by raising R 2 prior o ADR or SEO evens. 22

23 SEO. In paricular, we esimae he following model on a panel of CRSP firms during (see Appendix B for deails on sample consrucion): (2) η δ ε 2 log( R ) i, = α + βk (SEO has occured k periods earlier) i, + γfirm Conrolsi, + i+ + i, k For he dummy variables indicaing SEO has occurred k periods earlier, k {-,,+}, where k = - denoes -2 years prior o SEO, k = denoes he year of SEO, and k = + denoes -2 years afer SEO. Firm conrols consis of he same se of variables as in Table 2, namely beas, size, leverage, ROA, and Marke-o-book. η i and δ are firm and year fixed effecs, respecively. Τhe β k s are he coefficiens of ineres and we es he following hypoheses. Hypohesis derives direcly from he firs par of Proposiion (a). Hypohesis 2 derives from he second par of Proposiion (a). 6 Hypohesis. To he exen ha here is lumpy and early informaion disclosed a or before he SEO, R 2 should be higher subsequen o he offering. Tha is, β k < for some k>. Hypohesis 2. To he exen ha lumpy informaion is disclosed prior o or a he SEO, he R 2 would be lower a he ime of disclosure. Tha is, we expec β k > for some k. 6 We noe ha in he conex of SEOs he relaive imporance of ime-invarian informaion disclosure may no be significan as in some oher conexs such as cross-lisings (which will be discussed laer) or IPOs. Therefore we do no expec he effec of informaion disclosure o persis. Indeed, when we experimen wih alernaive specificaions wih longer horizons, we do no find any significan effecs beyond wo years. 23

24 One concern abou empirical idenificaion of he SEO effecs is he poenial selfselecion of SEOs. Tha is, SEOs are no randomly assigned; here migh be unobserved firm characerisics ha simulaneously affec he SEO decisions and reurn synchroniciy. In his paper, we explicily address his concern in hree ways. Firs, we are no relying on a simple regression of R 2 on an SEO dummy. Raher we focus on a non-monoonic dynamic response of reurn synchroniciy o he SEO. For he self-selecion argumen o work, i has o be he case ha cerain SEO-relaed firm characerisics can influence R 2 in boh posiive and negaive direcions and ha such influences change over ime in he exacly same way as our proposed dynamics in SEO effecs. This, however, is by no means obvious. Second, we include firm-fixed effecs in all our esimaions. This wihin-variaion specificaion effecively racks he same firm before and afer is SEO. Thus, o he exen ha some ime-invarian firm characerisics affec he SEO decisions, hese are compleely conrolled for. Moreover, we include in our regressions (ime-varying) firm-level conrol variables ha could poenially affec reurn synchroniciy and SEO decisions, such as size, profiabiliy, Marke-o-book, and leverage. B.2. Resuls Panel C of Table presens he summary saisics of our sample. Compared o non-seo firm-years, SEO firm-years differ in almos all firm characerisics, suggesing ha firm characerisics need o be conrolled for in our laer analysis. Table 3 repors he regression resuls. Column () in Table 3 is a naïve regression of -R 2 on a dummy variable indicaing -2 years immediaely afer a SEO. The coefficien on he pos- SEO dummy is significanly negaive a he % level. Tha is, conrary o he convenional 24

25 wisdom, SEO (and presumably greaer ransparency) is associaed wih less firm-specific reurn variaion in he years immediaely afer he offering. [Inser Table 3 here] While he above resul is consisen wih our conjecure ha, when he lumpy informaion is disclosed, here is less surprise aferwards, he specificaion does no consider he possible iner-emporal effecs of lumpy disclosure. Therefore, in columns (2)-(5) of Table 3, we inroduce he dynamic response of R 2 as specified in equaion (2). Consisen wih Hypoheses and 2, R 2 is lower prior o SEO, and increases subsequenly (significan a he % level or above). The impacs of oher firm conrol variables are similar o hose in Table 2. We plo he R 2 dynamics in Figure 2 (Panel A), which reflecs poin esimaes in column (3) of Table 3 based on indusry-augmened marke model. We sar wih he R 2 during normal imes (non-seo firm years), which is.7. Coefficiens β k ranslaes ino R 2 ha are abou one percenage poin lower before an SEO and one percenage poin higher during SEO year and one-o-wo years aferwards. [Inser Figure 2 here] C. Firm-Specific Reurn Variaion and Cross Lisings We now explore he dynamic response o anoher lumpy informaion disclosure even, namely ADR lisings. We use a very similar specificaion o he one for SEOs. ADR lisings are likely o be bigger informaion evens han SEOs, as he lising firms need o, in addiion o he 25

26 usual disclosure, comply wih SEC regulaions which ypically require more disclosure han exchanges in heir home counries. Thus he effecs of ADR lisings are likely o happen earlier, saring as soon as he firms begin o prepare disclosure and accouns for he lisings, and las longer. This is because, firs, he lumpier disclosure may remove more uncerainy abou imeinvarian aribues such as managerial abiliy, and second, he disclosure environmen subsequen o ADR lising may change o one ha involves coninued early regular disclosure. Then according o our Proposiion (b) and Proposiion 2, he reurn synchroniciy may coninue o be higher. However, exacly how long he posiive ADR effec lass is an empirical maer. Thus we esimae he following model: (3) η δ ε 2 log( R ) i, = α + βk ADR lising occured k periods agoi, + γfirm Conrols i, + i+ + i,. k For he dummy variables indicaing ADR lising had occurred k periods earlier, we consider k = - 2, -,, + and +2. In paricular, k = -2 and k = - correspond o years 3-4 and -2 before lising, k = corresponds o he year of lising, and k = + o +4 correspond o years -3, 4-6, 7-9, and more han years afer lising. Firm conrols consis of he same se of variables as in equaion (2), namely beas (home bea and U.S. bea), size, leverage, ROA, and Marke-o-book. We address he concern of self-selecion of ADR lisings in a similar manner o he SEOs. In paricular, we focus on he non-monoonic dynamic response of reurn synchroniciy o he ADR lising. η i are firm-fixed effecs which conrol for ime-invarian firm characerisics ha migh have affeced he ADR decisions. δ are year fixed effecs. 26

27 Table 4 provides he descripive saisics for our sample. Compared o non-adr firmyears, in ADR firm-years (i.e. a year in which an inernaional firm has an acive ADR), firms end o have significanly higher R 2, larger size, higher Marke-o-book, and higher leverage (a he % levels). 7 Ineresingly, he ADR firm-years end o have lower profiabiliy measured by ROA in mean bu no in median. Since in ADR firm-years, firms on average are more levered, he lower ROA in mean could be due o higher leverage. [Inser Table 4 here] Mulivariae analysis is presened in Table 5. 8 Again Column () of Table 5 is a naïve regression of -R 2 on he ADR dummy indicaing wheher or no he firm has an ADR lising. I shows ha ADR lising (and presumably greaer ransparency) is associaed wih significanly less firm-specific informaion in he sock prices (a he % level), conrary o he convenional wisdom. 9 Column (2) of Table 5 examines he dynamic responses of R 2. Consisen wih our model s predicions, ADRs are associaed wih a persisen drop in firm specific informaion in sock prices (i.e., higher R 2 ) in he years afer he lisings. The coefficiens on dummies indicaing years prior o he ADR lisings are significanly posiive (a he % level), implying 7 We noe ha LSSE does no differ significanly across he wo groups. This is no surprising since meaningful comparison of LSSE can only be made when he oal reurn variaion is conrolled for. 8 Here we do no use Fama-French hree-facor model or a four-facor model, since here is evidence in he asse pricing lieraure ha he size and book-o-marke facors do no work very well for a leas some inernaional socks (e.g., European or Japanese socks). 9 We noe ha his resul is quie differen from a conemporaneous paper by Fernandes and Ferreira (28). The differences could be due o mehodological differences: Fernandes and Ferreira (28) measure reurn synchroniciy 2 2 using log[( R ) / R ] (which is log[sse / (SST SSE)] ) and hey do no conrol for oal reurn variaion (SST). Thus even if a variable (X) does no affec SS E, i is possible o have a significan coefficien for his variable in he regression due o is correlaion wih SST. This is because d log[sse / (SST SSE)] / dx = [SST / SSE(SST SSE)] dsse / dx [ / (SST SSE)] dsst / dx, which is no zero even if dsse / dx =. 27

28 ha more firm-specific informaion is impounded in he sock prices a he ime of disclosure. The coefficiens on oher conrol variables are similar o hose in Table 3. 2 [Inser Table 5 here] We now examine how he inerplay beween insiuional facors and improved informaion disclosure affec he reurn synchroniciy dynamics. For share prices o reflec informaion, arbirageurs need o expend resources uncovering proprieary informaion abou he firm (Grossman (976), and Shleifer and Vishny (997)). Such arbirage aciviy, as argued by MYY (2), may be economically unaracive in counries wih poor proecion of propery righs due o he influence of unpredicable poliical evens and uncerainy abou he arbirageurs abiliy o keep heir rading profis. On he oher hand, recen lieraure on inernaional corporae governance finds ha firms incenives o disclose informaion and improve ransparency are weaker wihou developed insiuions. These consideraions sugges ha he dynamics of reurn synchroniciy surrounding he lising of ADRs are likely o be sronges for firms from counries wih srong insiuions. We divide he sample ino firms from counries wih beer insiuional developmen and hose wihou, based on he good-governmen index consruced by Kaufmann, Kraay, and Masruzzi (24) (KKM (24) hereafer). 2 Specifically, we define counries wih a score above 2 We noe ha some firms may cross lis in counries oher han he U.S. Thus our non-adr sample may conain firms which cross-lised ouside he US. To he exen ha some of such cross lisings are from weak law counries o counries wih beer disclosure requiremens, our resuls could be weakened. As a robusness check, we drop cross lisings ouside he U.S. from he conrol sample. The resuls (unrepored) remain qualiaively he same and are available upon reques. 2 KKM (24) provide six indicaors on insiuional environmen. Using he alernaive indicaors does no aler our resuls, which is no surprising since he correlaions beween any wo indicaors are over 7%. The indicaors are available afer 996. Since insiuional environmen changes very slowly, for observaions before 996, we use he value in

29 zero, he median of he scores for he good-governmen index in KKM s (24) sample, as hose wih developed insiuions, and counries wih a score below zero as wihou. Among 782 crosslised firms, 685 are from counries wih good insiuional suppor. Resuls in columns (3) and (4) of Table 5 show ha, consisen wih our conjecure, he dynamic effecs of ADR lisings in columns (2) are driven by firms in counries wih developed insiuions. A chow es indicaes ha he difference beween he wo groups of counries is significan a he % level. Panel B of Figure 2 shows he R 2 dynamics based on poin esimaes in column (2) of Table 5. We sar wih he R 2 during normal imes (non-adr firm-years), which is.89. R 2 is approximaely four percenage poins lower before ADR evens and four percenage poins higher aferwards. Such an effec is larger han in he case of SEO evens, reflecing he more lumpy naure of informaion disclosure around ADR lisings. So far he findings correspond well wih he implicaions of our model concerning changes in firm-specific reurn variaion in response o a change in he informaion environmen. We provide hree pieces of evidence. Firs, we find ha, consisen wih learning abou imeinvarian informaion, reurn synchroniciy is srongly posiively relaed o age. Second and hird, exploiing seings wih lumpy informaion disclosure during SEO and ADR evens, we find a dynamic response of reurn synchroniciy o lumpy informaion disclosure. In paricular, while a he ime of informaion disclosure reurn synchroniciy is lower, reflecing greaer firm-specific informaion impounded in he sock prices, reurn synchroniciy afer he disclosure (and hus wih greaer ransparency) is significanly higher. One remaining concern is ha, since SEO or ADR evens can be relaed o oher significan corporae evens, i is possible ha informaion disclosures surrounding hese evens, raher han SEO or ADR evens hemselves, lead o observed changes in reurn synchroniciy. I 29

30 is worh noing ha while his hypohesis changes he inerpreaion of our resuls, i does no refue our main poin ha here is a dynamic paern in reurn synchroniciy surrounding informaion disclosure and ha such a dynamic change is inconsisen wih he convenional wisdom. Moreover, he iming of hese oher evens has o be exacly he same as SEO/ADR evens; oherwise we would no be able o observe he dynamic paern around he laer. In fac, as we discuss earlier, his is a srengh of our empirical design i is much less likely for a prediced dynamic paern (i.e., increased pre-even SSE and decreased pos-even SSE) o arise spuriously. In an effor o disinguish beween changes in reurn synchroniciy due o oher corporae evens and changes due o SEO/ADR evens, we conrol for large changes in asses, as well as heir ineracions wih he SEO/ADR relaed dummies, given ha significan corporae evens are ypically associaed major changes in asse size. I urns ou ha hese ineracion erms are generally no significan and ha our main resuls remain. In he ineres of breviy we do no repor hese resuls bu hey are available upon reques. V. Conclusion Exising lieraure has aken he perspecive ha if a firm s informaion environmen causes sock prices o reflec more firm-specific informaion, marke facors should explain a smaller proporion of he variaion in sock reurns. This paper broaches, heoreically and empirically, anoher perspecive: ha sock prices respond only o announcemens ha are no already anicipaed by he marke. When he informaion environmen of a firm improves and more firm-specific informaion is available, marke paricipans are able o improve heir predicions abou he occurrence of fuure firm- 3

31 specific evens. As a resul, he surprise componens of sock reurns will be lower when he evens are acually disclosed, and he reurn synchroniciy will be higher. Our empirical evidence is drawn from hree differen seings. Firs, consisen wih learning abou ime-invarian informaion, reurn synchroniciy is significanly higher for older firms. Second and hird, exploiing seings wih disclosure of subsanial informaion abou he firm, namely seasoned equiy issues and ADR lisings, we find dynamic responses of reurn synchroniciy ha are consisen wih lumpy and early disclosure of informaion relevan for fuure evens, as well as disclosure of informaion perinen o ime-invarian firm aribues ha are relevan for fuure cash flows. In paricular, reurn synchroniciy decreases prior o hese evens, and increases subsequenly. Overall, we make wo conribuions o he lieraure. Firs, by showing boh heoreically and empirically ha sock reurn synchroniciy can increase wih improved firm ransparency, we highligh he imporance of undersanding he naure of informaion discovery and he dynamics of response of sock reurn synchroniciy o changes in informaion environmen. Second, our analysis adds o he growing body of lieraure on informaion disclosure around securiy issuance evens. 3