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By Catherine M. Schrand and Robert E. Verrecchia

Abstract

The negative relation between returns and return volatility, referred to as the “leverage effect”, has been a puzzle in the finance literature since the 1970s. Strategic disclosure of good news and withholding of bad news provides a potential explanation. Good news disclosures imply a positive share price response and a reduction in residual uncertainty; inferences of bad news imply a negative share price response and a smaller reduction in residual uncertainty. We document that the leverage effect is stronger for firms in industries with greater return synchronicity, following the Private Securities Litigation Reform Act of 1995, and for firms in Canada relative to the U.S. These three patterns suggest that the leverage effect is stronger in environments in which strategic disclosure of good news and withholding of bad news is more likely to characterize disclosure decisions. Thus, the evidence is consistent with the effects of this disclosure strategy on uncertainty as an explanation for the negative relation between returns and return volatility. Does strategic disclosure explain the ‘leverage effect’? An empirical regularity is that returns are negatively related to return volatility. Black (1976) provided an early explanation for the phenomenon. As returns increase, market leverag

Year: 2011
OAI identifier: oai:CiteSeerX.psu:10.1.1.196.1111
Provided by: CiteSeerX
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