The role of transparency in financial institutions and credit markets

Lee, Yun (2019) The role of transparency in financial institutions and credit markets. Doctoral thesis, University of London: London Business School.

Abstract

The thesis examines the role of transparency in the functioning of financial institutions and credit markets in three chapters. The first chapter examines how mandatory periodic public disclosures of mutual funds, a key device for their transparency, affect their redemption risk. Using a sample of U.S. equity and bond funds, this chapter documents that conditional on poor performance, funds suffer higher capital outflows during the disclosure period. This increase in redemption risk is driven by two disclosure-related factors. Disclosures make fund investors more sensitive to performance by enabling them to assess fund fundamentals better. Disclosures also induce fund investors to withdraw capital at a higher level of perfor-mance by reinforcing their beliefs that other investors will withdraw capital. The second chapter examines how enhanced transparency of asset-backed securities affects their market liquidity. Exploiting a European disclosure regulation that required a release of detailed information about the fundamentals of the securities, this chapter documents that liquidity drops after the regulation takes effect. Using such public information, sophisticated investors generate private information about the performance of the securities to make profitable trades. Unsophisticated investors, who are unable to produce such private information, face the typical adverse selection problem and pull out of the market. Enhanced transparency hurts liquidity by increasing information asymmetry among investors. The third chapter examines how the overall information opacity of corporate bond issuers affects the unexpectedness of their bond defaults. Using a sample of North American bond defaults, this chapter documents that defaults occur more unexpectedly for more opaque firms. In particular, firms that provide more complex financial reports, record off-balance sheet liabilities and mark-to-model assets, and make fewer voluntary disclosures experience more unexpected defaults. Defaults also occur more unexpectedly when there is a larger disparity among financial analysts and among rating agencies, and when the firm receives less media coverage. Overall, the thesis contributes to the ongoing debate on the role of transparency in the stability of the financial system.