It has been a long held belief among financial economists that when a firm's information disclosure is less transparent, its stock price reflects less firm-specific information as opposed to market-wide information. That is, its stock price synchronicity, the proportion of variation in stock return that can be explained by the market factor, will be high.

Think about countries like China or other emerging markets where the quality of information disclosure is poor, on a given day if the market goes up, almost all the stocks go up and if the market falls, most stocks fall. These are typical examples of high stock return synchronicity, which has been used by many analysts as a measure of information transparency. Sensible, but not necessarily right, argues a new study.

Sudipto Dasgupta, Jie Gan and Ning Gao take the view that stock prices respond mainly to things that are not already known. Therefore, the more information about a company that is out there, the fewer surprises will be awaiting investors. As a result, prices will show a higher stock return synchronicity, that is, stock returns will be more affected by market-wide factors than firm-specific ones.

"Our point is that a more transparent information environment can lead to higher rather than lower stock return synchronicity because stock prices respond only to announcements not already anticipated by the market," they say.

"When the information environment of a firm improves and more firm-specific information is available, market participants are able to improve their predictions about the occurrence of future firm-specific events. As a result, the surprise components of stock returns will be lower when the events are actually disclosed, and return synchronicity will be higher."

They test this idea by looking at two types of firm information: time invariant, such as managerial quality, and time variant, which describes the release of big blocks of information about future events such as occur around seasoned equity issues (SEOs) and cross listings of stocks on more than one foreign exchange (here referred to as ADRs for American depository receipts).

The authors argue that time invariant information is more likely to affect synchronicity in older firms because this type of information is likely to be revealed, or learned, over time, and they show this to be the case in tests on US firms from 1976-2004. Older firms that were at least three years past their initial public offering had higher stock return synchronicity than younger ones.

Next they looked at time variant information - and the heart of how greater transparency affects stock return synchronicity. Although they find different magnitudes in the effects of SEOs and ADRs, both move in the same direction.

Stock return synchronicity is about one per cent higher in the one to two years following the SEO year, and one per cent lower in the year prior to the SEO year. For ADRs, the numbers are even more significant - four per cent higher following the ADR year and four per cent lower beforehand.

"ADR listings are likely to be bigger information events than SEOs as the listing firms need to, in addition to usual disclosure, comply with SEC regulations that typically require more disclosure than exchanges in their home countries," the authors say.

"Our model suggests a dynamic response of return synchronicity to an improvement in the information environment. At the time when new information is disclosed and impounded into stock prices, the firm-specific return variation will increase. But since a big chunk of relevant information is already reflected in stock prices, the firm-specific return variation of SEO and cross-listed firms will be subsequently lower," they say.

In other words, greater transparency today can mean higher stock return synchronicity in future, contrary to the conventional wisdom