Predisclosure Information, Firm Capitalization, and Earnings Information Transfers

different levels of predisclosure information production and dissemination. Empirical evidence supports this size-related information Accordingly, because information search activities yield higher expected hypothesis. The magnitude of abnormal returns associated trading profits for larger firms, prices are “more informative” for larger with both good and bad earnings information has been shown firms and their earnings reports convey less information. This phenomenon to be inversely related to firm size. For example, Freeman, is called the size-related differential information hypothesis. Moreover, (1987, Tables 6–8) finds cumulative abnormal returns of small asset pricing theory views prices as a function of all information—including firms to exceed those of large firms by more than 40%. Also, information about other firms. This multilateral perspective is consistent Atiase (1985) reports greater stock return variability for earnwith earnings reports yielding price revaluations for other firms, called ings announcements of small firms. He finds announcement earnings information transfers. This article hypothesizes that the sizeweek return variances of small firms to exceed those of large related differential information hypothesis extends to earnings information firms by more than 200%. In both of these studies, this sizetransfers. It predict and shows that price revaluations to earnings are related phenomenon is attributed to different levels of predisinversely related to the size of both disclosing and non-disclosing firms. closure information production and dissemination by private This evidence supports the multilateral price implications of earnings. parties for firms of different sizes. J BUSN RES 2000. 49.273–288.  2000 Elsevier Science Inc. All rights The implications of this differential information hypothesis reserved. extend beyond the individual firm. For example, the widely accepted conceptualization of asset pricing views firms’ stock prices as a function of the entire information available to Different incentives for information search are asserted market participants—not just own-firm’s information set to systematically affect the informativeness of stock (Harris, 1987; Schipper, 1990). Such a representation suggests prices for firms of different sizes (Atiase, 1985; Freethat a firm’s price is not only a function of its own disclosures man, 1987; Collins, Kothari, and Rayburn, 1987). Larger firms but also of other firms’ disclosures (so-called information are argued to possess more informed prices due to greater transfers). [Evidence of information transfers is considerable; information production and dissemination by private parties. e.g., see Baginski (1987), Clinch and Sinclair (1987), Foster This is because private parties are drawn to larger firms by (1981), Freeman and Tse (1992), Han and Wild (1990), Olsen higher expected trading profits. An investor pursues informaand Dietrich (1985), Pownall and Waymire (1989), and Pyo tion search so long as its cost is less than its expected trading and Lustgarten (1990).] The size-related differential informaprofit. This implies more informed prices for larger firms if tion hypothesis has obvious implications within this multilatmarginal trading profits increase with firm size, and at a greater eral view of the determination of firms’ prices. That is, not rate than marginal search costs. Trivially, if search is costless, only is the information content of a firm’s own disclosures then trading profits vary in strict proportion to firm size (marinversely related to its size, but so to are its information ket value). Hence, because information production and distransfers to other firms. Hence, accounting disclosures of semination by private parties is an increasing function of firm smaller firms should yield greater price revaluations for its own stock and stocks of other firms. From the perspective of private parties interested in firm valuation, the incentives for Address correspondence to Dr. John J. Wild, Grainger School of Business, University of Wisconsin, 975 University Avenue, Madison, WI 53706-1323. information search (i.e., to explore the information transfer