Firm Opacity Lies in the Eye of the Beholder

We classify and test empirical measures of firm opacity and document theoretical and empirical inconsistencies across these proxies by testing the relative opacity of banks versus non-banks. We evaluate the effectiveness of these proxies by observing the effect of two cleanly identified shocks to firm-specific information: credit rating initiation and inclusion in the S&P 500 index. Using a difference-in-difference approach, we compare firms that are newly rated and firms that are included in the S&P 500 index with a propensity matched sample of “unchanged” firms. We find that only the number of analysts and Amihud's illiquidity ratio provide consistent patterns across different estimation specifications and different econometric settings. These two proxies show that banks are more opaque than non-banks. Based on our tests, we recommend that these proxies be used as the primary measures of firm opacity.