Improving Disclosure Incentives for Thinly Traded Stocks by Varying the Market Microstructure
Finance & Accounting
|Speaker:||Ivana Raonic , Cass Business School|
|Date:||Friday 26 March 2010|
Two distinct literatures discuss their own interpretations of ‘transparency’ associated with trading stocks. The disclosure literature adopts an interpretation for transparency in terms of the visibility of communication that a firm adopts for public releases of information to the market. This literature focuses upon the quantity and quality of the contents of corporate news wire releases and financial statements. In contrast the market microstructure literature adopts an interpretation in terms of the level of visibility of the trading process used to auction a stock. In this literature the focus is upon the differential information that agents such as market makers have in the details of the auction trading process in order driven versus quote driven markets or some hybrid variant. To date these two literatures have remained largely separated.
In this research we argue that for thinly traded stocks the incentives for firms to improve disclosure of their market position and prospects depends critically upon the market microstructure within which the stocks are traded. Thus for instance, if regulators or stock exchanges adopt an objective of wanting to improve the market visibility of previously thinly traded stocks we suggest it is insufficient to simply recommend or require such firms simply increase disclosure. This research suggests that the benefits from increased disclosure may only be captured by the firms if an appropriate trading mechanism is simultaneously put in place since otherwise other interested parties such as market makers, and not the firms, may capture the gains from increased disclosure. The research uses the London Stock Exchanges AIM market, introduction of a hybrid order driven system (initially called SETSmm) to test for the differential benefits of disclosure associated with a change in market microstructure. The contribution of this research is to understand the interactions between trading mechanism design and the economic incentives for disclosure to show how variation in trading mechanism affects the net benefits of disclosure for thinly traded firms.