The relation between corporate voluntary disclosure and stock liquidity plays an important role in our understanding of managers’ information supply incentives and market quality. Studies on the relation between voluntary disclosure and liquidity primarily explore how voluntary disclosure affects liquidity. This line of the literature suggests that voluntary disclosure is useful in shaping liquidity in that it alleviates information asymmetry among investors, decreases the trading costs arising from adverse selection, and thus improves liquidity. Accordingly, managers employ voluntary disclosure as a strategy to shape stock liquidity, especially when stock liquidity is low.
These studies show that voluntary disclosure positively affects liquidity and imply that liquidity is endogenouslyaffected by the information environment. However, many factors that are exogenous with respect to the information environment also have substantial influences on stock liquidity. It is not clear whether and how such an exogenousliquidity change affects corporate voluntary disclosure decisions. In this study, we examine the effect of an exogenousliquidity change on voluntary disclosure by employing the 2016 SEC Tick Size Pilot Program (henceforth, the TSPP).
The TSPP provides us with an ideal setting to study whether and how an exogenous liquidity shock affects managers’ disclosure incentives. To boost liquidity provision and analyst coverage for small-capitalization firms, the SEC started the tick size pilot program by switching the minimum trading unit (i.e., tick size) of a set of randomly selected small-capitalization stocks from one cent to five cents during the period of October 2016 to September 2018 (WSJ 2016). Despite the intention to improve liquidity of small-cap firms, studies on this pilot program suggest that, on average, pilot firms experience a reduction in stock liquidity. Meanwhile, the TSPP did not impose direct changes to the information environment, as the sample selection process and experiment treatment are both unrelated to disclosure practices. Hence, we can use the TSPP to isolate the portion of exogenous liquidity variation resulting from the change in tick size but not directly related to the corporate information environment.
We argue that the liquidity decline induced by the TSPP may lead to reduced voluntary disclosure. The liquidity reduction may have an attenuation effect on the market reaction to voluntary disclosure, which is likely to weaken both managers’ incentive to disclose and investors’ demand for voluntary disclosure. Specifically, limited liquidity may hinder the market from impounding the information into stock prices in a timely and sufficient manner. As a result, managers’ ability to influence stock prices using disclosure is weakened, thus reducing the expected benefits they can gain from voluntary disclosure. Meanwhile, investors may trade less and thus have lower demand for disclosure because low liquidity imposes additional trading costs. As a result, less trading leads to lower propensity for investors to require information from managers and thus make managers refrain from disclosure.
Using the sample of pilot and control stocks designated by the SEC, we perform difference-in-differences analyses with firm fixed effects around the implementation of the TSPP to examine whether and how firms respond to the TSPP by adjusting their voluntary disclosure. With management earnings forecasts as the primary measure for voluntary disclosure, we find that the treatment firms significantly reduce the frequency of earnings forecasts after the start of the TSPP, while control firms do not exhibit a significant change. Specifically, relative to that of control firms, the frequency of management earnings forecasts reduces by 15% relative to the mean of our sample. The effect is both statistically and economically significant and robust to a broad set of robustness checks. In addition, our further analyses support that there is a causal effect of the liquidity shock amid the TSPP on voluntary disclosure decisions. To generalize our findings, we also employ conference calls and voluntary 8-Ks as alternative voluntary disclosure proxies. We show that treatment firms also reduce the frequency of conference calls and voluntary 8-K filings after the TSPP relative to control firms.
To further support our causal inferences, we further exploit the termination of the TSPP in September 2018. If the quantity of voluntary disclosure reverses after the termination, it is more likely that our findings are due to the pilot program. We show a consistent reversal that the frequency of management earnings forecasts reverses for treatment firms after the termination and that the post-termination disclosure level is not significantly different from the pre-implementation level.
We further explore the cross-sectional variations of our main findings. We show that managers will reduce their voluntary disclosure to a larger extent when the liquidity decrease during the TSPP is severe. Also, we expect and find that firms with lower expected marginal benefits of voluntary disclosure before the TSPP are more likely than others to refrain from disclosure after the TSPP. We also consider if the change in investors’ information acquisition activities and algorithmic trading during the TSPP explains our findings but find no consistent evidence.
Our study contributes to research on the relation between stock liquidity and voluntary disclosure. Besides the well-documented effect of voluntary disclosure on stock liquidity, our study indicates that stock liquidity also affects voluntary disclosure and thus complements the studies on the disclosure-liquidity relation. In addition, we provide timely evidence on the impact of the TSPP from an accounting perspective. Extant studies investigate market microstructure changes and asset pricing implications. In contrast, our study shows indirect and unintended impacts of the TSPP on corporate disclosure decisions. Our findings may be relevant for regulators who are reviewing the TSPP and considering the reform on the tick size.
Ole-Kristian Hope is Deloitte Professor of Accounting at Rotman School of Management, University of Toronto.
Junhao Liu is an accounting PhD student at Rotman School of Management, University of Toronto.
This post is adapted from their paper, “Does Stock Liquidity Shape Voluntary Disclosure? Evidence from the SEC Tick Size Pilot Program”, forthcoming in Review of Accounting Studies and available on SSRN.
