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RESEARCH BRIEF: Transparency leads to higher liquidity and lower transaction costs in many operating contexts


Takeaway:  Transparent companies achieve higher liquidity and lower transaction costs making the company more attractive to investors. Researchers find transparency to be of greater importance for companies operating in countries at risk for corruption, in time periods of greater price volatility (poor economy), and when the companies are thought to have a weak governance structure (concentrated ownership).

Suggested audience:  Corporate citizenship managers building a business case, chief financial officers

This research took 97,799 firm-year observations from 46 countries (largest being from Japan, United Kingdom, China, Canada, Malaysia, Germany, and France) from the Thomson Reuter’s database in order to investigate the link between transparency, liquidity, cost of capital and firm valuation across countries. They used earnings management, auditor quality, and adoption of international accounting standards as the main measures of a firm’s financial transparency. The firm’s proportion of zero-return trading days over the fiscal year then measured the firm’s stock liquidity, and the median bid-ask spread over the fiscal year measured transaction costs. 

Furthermore, in the research they looked at the importance of transparency broken down in different contexts:

  • Country – Whether a firm’s operating country has a significant amount of corruption
  • Time period characteristics – Periods with greater investor uncertainty during which share price volatility is high
  • Firm – Whether a firm is expected to have poor internal governance, especially with high levels of concentrated ownership

Key findings include:

  • Liquidity is higher and transaction costs are lower for firms that do not practice earnings management (smoothing cash flows through accrual manipulation); are audited by top-tier audit firms; and are committed to following international accounting standards
  • Firm-level transparency is particularly important in regards to liquidity for organizations operating in countries at risk for corruption, where there is likely to be significant self-dealing, disclosure requirements are weak, and media penetration is low
  • Regardless liquidity tends to be lower during periods of high price volatility, but the effect of high volatility on liquidity is substantially mitigated for firms with higher transparency levels
  • The positive relationship between transparency and liquidity is substantially stronger for firms with expected governance issues (high concentration of ownership), thus making transparency particularly important

 “Transparency, Liquidity, and Valuation: International Evidence on When Transparency Matters Most”, Journal of Accounting Research, 2011, Mark Lang, Karl V. Lins, and Mark Maffett

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