Report on R2 as a Measure of Firm-Specific Information at Cross-Country Level 1. Introduction
This report is based on the literature of Alves et al. (2010) to critically examine the idea of whether R2 can be a good measure to evaluate the information environment quality at cross-country level. Alves et al. (2010) made an argument on whether the measure of R2 was adequate to evaluate the quality of cross-country information environment based on the research of Morck et al.’s (2000). Alves et al. (2010) summarized the main ideas of Morck et al.’s literature at the beginning of their article and also presents some prior researches on R2. In most prior researches, such as Morck et al.’s (2000), experts believed that corporate stock prices were more likely moving together in poor condition of economies than in rich economies. Since poor economies tend to have less strong property rights and corporate governance as well as the enforcement mechanisms with less efficiency, thus the prices are more easily co-move with the market. (Alves et al., 2010) Also in the literature of Mork, yeung and Yu (MYY, 2000) claimed that R2 and other means of stock market synchronicity are higher in countries with lower GDP and poor financial systems. (Jin, Myers, 2006) However, does the R2 always reflect the accurate information? Some other studies proposed their idea that there is another possibility that at the beginning the amount of firm-specific uncertainty is high which results in low R2, whereas the uncertainty may cause high R2 in the future. (Teoh, Yang, Zhang, 2007) This report critically evaluates the debate about the reliability of R2 at cross-country level. In the second section, the contribution of the study will be presented. The Third section will discuss the importance of R2 study for the direction of future research. The fourth section will critically evaluate the reliability of R2 in multinational circumstances. At last but not least a conclusion of this report will be summarized. 2. The Contribution within a Developing Body of Research
As the appearance of high frequency and vanishing barriers of international trade as well as the capital mobility is increasing, so that the need of country-specific information is increasing, and a better understanding of international stock market for investors is necessary. (Alves et al., 2010) Meanwhile regulators are doing their best to harmonize both sides of capital market regulations and financial reporting rules. (Alves et al., 2010) Thus the study of the information environment quality both within country and at cross-country level can help understanding the dynamics of information and formulate regulations. (Alves et al., 2010) A good example which can explain the importance of cross-country level information is cross-list companies, such as a non-U.S. company cross-list on the U.S. exchange market. In prior researches, there are some studies examine that a cross-listing firm can improve the incentives for different market participants and private information on trading, because cross-listing companies are committed to a higher level of information disclosure environment. Thereby it influences a company’s stock price. (Fernandes, Ferreira, 2008) Also, there are evidences showing that a strong asymmetric relation is between cross-listing condition and the stock return variation of a company. (Fernandes, Ferreira, 2008) Therefore an adequate measure of evaluating information quality is necessary, especially at cross-country level. Also, a stock market with functional efficiency is associated with a necessary condition which is the share prices are closely connected with firm fundamentals. According to the research of Roll (1988), the way that capitalizing fundamentals information into stock prices through the activities of risk arbitrageurs’ trading is vitally significant, of which indicates to a low R2. And there are researches present that firm-specific stock prices are positively...
References: Alves, P., Peasnell, K., Taylor, P. (2010). The use of the R2 as a measure of firm-specific information: A cross country critique. Journal of Business Finance & Accounting, 37 (1) & (2), 1 – 26.
Durnev, A. R. T., R. Morck and B. Yeung and P. Zarowin (2003), Does Greater Firm-Specific Return Variation Mean More or Less Informed Stock Pricing? Journal of Accounting Research, 41 (5), 797–836.
Fernandes, N. and M. A. Ferreira (2008), Does International Cross-Listing Improve the Information Environment, Journal of Financial Economics, 88 (2), 216–44.
Morck, R., B. Yeung and W. Yu (2000), The Information Content of Stock Markets: Why do Emerging Markets have Synchronous Stock Price Movements? Journal of Financial Economics, 58(1) & (2), 215–60.
Roll, R. (1988), R2 (R squared), Journal of Finance, 43 (3), 541–66.
Teoh, S. H., Y. Yang and Y. Zhang (2008), R-Square: Noise or Firm-specific Information, Working Paper (University of California, Irvine).
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