Clarity Begins at Home: Internal Information Asymmetry and External Communication Quality

Chen, Chen, Martin, Xiumin, Roychowdhury, Sugata, Wang, Xin, Billett, Matthew T.

The Accounting Review · 2018 · Volume 93 · Issue 1

Abstract

This paper investigates the effect of internal information asymmetry (IIA) within conglomerate firms on the quality of management forecasts and financial statements. We develop a novel measure to capture IIA between divisional managers and top corporate managers, computed as the difference in their respective trading profits on their own company's stock (DIFRET). Numerous validation tests indicate thatDIFRETindeed captures the information asymmetry between divisional managers and top managers. In our primary tests, we find thatDIFRETis associated negatively with the accuracy, bias, specificity, and frequency of management forecasts. Furthermore, the likelihood of error-driven accounting restatements increases withDIFRET. Our results, thus, suggest that external communication quality suffers when the information asymmetry between divisional managers and top managers is more severe.

Keywords

internal information asymmetry, management forecast, external communication

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