We present a model that links the opacity of an asset to its liquidity. We show that while low-opacity assets are liquid, intermediate levels of opacity provide incentives for investors to acquire private information, causing adverse selection and illiquidity. High opacity, however, benefits liquidity by reducing the value of a unit of private information. The cross-section of bid–ask spreads of US firms is shown to be broadly consistent with this hump-shaped relationship between opacity and illiquidity. Our analysis suggests that uniform disclosure standards may be suboptimal; efficient disclosure can instead be achieved through a two-tier standard system or by subsidizing voluntary disclosure.
Bibliographical noteFunding Information:
We thank participants of the Annual Meeting of the EFA 2014, the ESEM 2014, the ESWM 2014, as well as the ENTER Jamboree 2015, and seminar audiences at Cambridge Judge, ULB‐ECARES, Leicester, Rotterdam, Mannheim and Tilburg. We are grateful to Jacques Crèmer, Paolo Conteduca, Raphael Levy, Volker Nocke, Yuki Sato, Nicolas Schutz and Ernst‐Ludwig von Thadden for valuable comments. Funding by the German Research Foundation (DFG) via the CRC TR 224 (Project C3) is gratefully acknowledged.
© 2021 The Authors. Journal of Business Finance & Accounting published by John Wiley & Sons Ltd