Transparency, Liquidity, and Valuation: International Evidence

We examine the relation between transparency, stock market liquidity, and valuation for a global sample of firms. Following the prior literature, we argue that transaction costs will be higher and investors will be less willing to transact if they perceive significant issues with respect to transparency, particularly in international settings where potential information effects are more pronounced Consistent with expectations, we document lower transaction costs and greater liquidity (as measured by lower bid-ask spreads and fewer zero return days) when transparency is likely to be higher (as measured by less evidence of earnings management, better accounting standards, higher quality auditors, more analyst following and more accurate analyst forecasts). We also find evidence that the relation between transparency and liquidity is more pronounced when country-level investor protections and disclosure requirements are poor, suggesting that firm-level transparency matters most when country-level institutions are weak. Finally, we provide evidence that increased liquidity is associated with lower implied cost of capital based on an analyst-forecast-based valuation model, and with higher valuation as measured by Tobin's Q. Magnitudes are substantial, with an interquartile increase in transparency in a low investor protection country associated with a decrease in bid-ask spread from 1.9% to 0.9% and a decrease in cost of capital of 62 basis points.