Exogenous Liquidity Increases and Voluntary Disclosure

This study examines the impact of an exogenous increase in liquidity, unrelated to the information environment, on voluntary disclosure. We employ a simple model in which managers optimize disclosure such that the marginal benefits of disclosure via a reduction in the cost of capital equals the marginal costs of disclosure in the form of information production and proprietary costs. The model predicts that an exogenous increase in liquidity will affect the marginal benefits to marginal costs relation, resulting in a reduction in voluntary disclosure. We test this prediction using a setting where a regulatory intervention exogenously reduced transaction costs and therefore increased the liquidity of the firm’s stock. As predicted, we find that after the exogenous increase in stock liquidity, managers reduced voluntary disclosure relative to a control group. This effect is more pronounced in firms with lower public information demand (i.e., a lower marginal benefit of disclosure) and in firms with higher performance uncertainty (i.e., a higher marginal cost of disclosure). Lastly, we find that this reduction in voluntary disclosure disadvantaged less sophisticated investors by increasing information asymmetry among investors.