Thought of the Week - The value of transparency for smaller firms

A couple of days ago, I discussed how increased transparency and ESG reporting are able to lower the cost of capital for a business. But these benefits of increased transparency apply not just to ESG disclosures, but apparently to standard financial reporting as well. Vanessa Behrmann and her colleagues from the University of Bremen used a natural experiment to estimate how reduced financial reporting affects a company’s liquidity and valuation. And the effects are astonishingly large.

Joachim Thought Of The Week

The natural experiment was the elimination of mandatory quarterly reporting for stocks listed on the Prime Segment of the Frankfurt Stock Exchange. Before 2015, every company listed in Frankfurt had to provide full quarterly reporting like companies listed on the New York Stock Exchange, for example. After the reform, the companies still had to provide half-yearly reports but could cut their quarterly reports down to simple trading updates, i.e. their reporting requirements resembled those of the London Stock Exchange. Some companies took advantage of that reform and reduced their quarterly reporting, while others continued to provide full quarterly reports. And this difference allowed the researchers to estimate the impact of lower quarterly reporting information on share liquidity (measured as bid-ask spread) and company valuation (measured as price-to-book ratio and Tobin’s Q).

To quantify the different kinds of quarterly statements of companies after the reform, they classified them into four quality categories:

  1. A qualitative management update without any quantitative data.
  2. A simple trading update with a condensed update on income and cash flows.
  3. A quarterly report in accordance with IAS 34 but no interim management statement.
  4. A full quarterly report in accordance with IAS 34 and an interim management update, just like before the reform.

If the researchers looked at all the companies listed on the Frankfurt Stock Exchange, there was no statistically significant impact visible for companies abandoning full quarterly reporting. But the picture changed if one looked at small- and mid-size companies that are covered by fewer analysts and receive fewer media coverage. For these companies, the impact of reduced quarterly reporting was significant.

In terms of liquidity, the bid-ask spread for smaller companies increased by 2.8% to 3.5% in the year for every level they declined in their quarterly reporting quality (i.e. dropping from 4 to 3 or from 3 to 2). However, bid-ask spreads narrowed again over time and the long-run effect on share price liquidity was almost zero.

However, the impact on valuations was significant not just in the short term, but also in the long run. For every step down in quarterly reporting quality Tobin’s Q dropped by about 0.22 to 0.25. Given that the average Tobin’s Q of the stocks at the time of the reform was 1.87 that implies a 13% valuation discount for every level dropped in reporting quality. When value was measured as price-to-book, then every step down in quarterly reporting quality reduced the ratio by 1.0x from a starting average of 3.4x – a 30% drop in valuation.

This drop in valuation seems driven by a lack of information in the market about these companies. Smaller companies are covered less by the media so if they are less transparent about their business, investors feel less informed and increase the risk premium they apply to the business. That media coverage and publicly available information is the key driver here can be seen by the fact that companies that are not members of the major German stock market indices experience a larger decline in valuations. These companies tend to be of even less interest to the media and are thus covered even less when they publish corporate updates. It is even more important then, to inform the public as comprehensively and transparently on a quarterly basis about the business. I know it is a lot of work to create a full-scale quarterly report but especially for smaller companies, it may well be worth it.

Thought of the Week features investment-related and economics-related musings that don’t necessarily have anything to do with current markets. They are designed to take a step back and think about the world a little bit differently. Feel free to share these thoughts with your colleagues whenever you find them interesting. If you have colleagues who would like to receive this publication please ask them to send an email to This publication is free for everyone.

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