Publicly disclosing information can have mixed outcomes for catering enterprises, according to Dr Jaehee Gim of the School of Hotel and Tourism Management (SHTM) at The Hong Kong Polytechnic University and co-authors. Using recent data from the US, they reached this conclusion after probing the link between information asymmetry and firm value in the famously saturated and competitive restaurant sector. Their discovery of a curvilinear form of the relationship was accompanied by new, practical insights into how the effect of information transparency on firm value is moderated by firm age and debt.
Managers know more about their own firms than investors do. This straightforward fact leads to the well-known information asymmetry problem, which originated in the context of second-hand car sales but also applies in management. It causes unfairness in the stock market because managers can disclose private information to benefit selected parties at their discretion. Asymmetric information can also reduce firms’ own value and give rise to moral hazard. “These information asymmetry problems can collectively distort market efficiency or lead to a complete breakdown of the market”, say the researchers.
Not all sectors are affected in the same way, however. The classical explanation of why information asymmetry hurts firm value is twofold: the resulting high uncertainty discourages investors from buying expensive stocks, while self-serving managers exploit their information advantage for personal gain at firms’ long-term expense. Yet in the restaurant sector, note the researchers, “an overly transparent information environment could also result in the deterioration of firm value”.
Catering is a notoriously uncertain market: restaurants face an environment of constantly shifting customer desires as trends pass by and new technologies appear. “Given customers’ rapidly and constantly changing needs”, say the researchers, “restaurant firms often choose to imitate their successful peers”. However, “disclosing too much information about a firm’s current and future status could create a situation in which the firm’s strategic information is inadvertently shared with its competitors”. This contradicts the usual expectation that sharing information should boost stock value by reducing asymmetry.
The authors thus set out to test, for the first time, the effect of information asymmetry on restaurants’ business value. Given the competing expectations outlined above, they hypothesised an inverted U-shaped profile, with firm value maximised at an intermediate level of information disclosure. Moreover, given the distinct features of the dining trade, they looked at two potential moderating factors of this relationship: firm age and financial leverage (indebtedness).
New restaurants have it tough: three in every 10 that go public are bankrupt within five years. Getting external financing is hard, as investors stand to make few capital gains due to the sector’s high overheads and tight margins; even industry giants have relatively low credit ratings. “Young restaurant firms are in great need of cash to fund quick expansion and thus survive the competitive market”, the authors warn. As small firm size is a significant determinant of restaurant firms’ being delisted, the authors proposed that firm size moderates the information asymmetry–firm value relationship, making asymmetric information more harmful for new ventures.
Managers of highly leveraged firms might be expected to rein in their self-interest under scrutiny from creditors. This is known as the “debt monitoring” hypothesis. Conversely, they might become even more opportunistic to avoid breaching the terms of debt covenants, ultimately harming firm value. Noting that lenders are extra-cautious in the high-risk restaurant sector, the authors reasoned that “creditors in the industry serve as effective monitoring entities for opportunistic managerial behavior”. They thus proposed that leverage weakens the negative effect of information asymmetry on firm value.
To test their hypotheses, the authors focused on the historical bid–ask spread of restaurant firms to measure information asymmetry, as the variation in opinion on companies’ stock value implies the existence of a few informed traders with private access to firm information. As an alternative measure of asymmetry, they calculated a composite index of analysts’ forecast dispersion and return volatility. “When little or no information about a firm’s performance is publicly available, analysts’ forecasts diverge”, the authors explain.
Companies’ ages and debt-to-equity ratios were also obtained to analyse the influence of firm age and leverage on the information asymmetry–firm value relationship. Finally, in this way the researchers obtained a data sample covering 51 restaurant businesses in the US between 1997 and 2019. Armed with this rich information, they proceeded to test whether their theoretical predictions matched the patterns in the data.
As hypothesised, the relationship between firm value and the bid–ask spread turned out to be non-linear. The results of the main test suggested that “a curvilinear (inverted U-shaped) relationship exists between information asymmetry, measured by the bid–ask spread, and firm value in the restaurant industry”. This indicates that restaurant businesses maximise their value when they publicly disclose a specific level of operational information. It is disadvantageous to stray from this point in the direction of either more information transparency or asymmetry.
Turning to the moderating role of firm age in this phenomenon, the results were mixed. When the bid–ask spread was used to measure information asymmetry, the authors’ prediction seemed to be confirmed. “The younger a firm is”, they explain, “the more downward and to the left the turning point of the inverted U-shaped curve is located”. That is, for newer restaurants, not only was firm value itself generally lower than for more established businesses, but the ideal extent of information asymmetry was also smaller. However, no significant relationship of this kind was found when using the composite proxy for information asymmetry.
Similar conclusions were derived when investigating how leverage intersected with the role of asymmetric information. According to the model using bid–ask spread data, “the more financially leveraged a firm is, the more upward and to the right the turning point of the inverted U-shaped curve is located”. Thus, less leveraged businesses were on average less valuable and benefited most from a lower level of information asymmetry. Again, however, the use of a composite proxy of information asymmetry caused this observation to vanish, which the authors tentatively attribute to limitations in the method of constructing the index.
The findings have some immediate managerial implications. “When firm managers in the restaurant industry engage in voluntary disclosure activities”, note the researchers, “they may have to keep in mind that the cost of keeping the level of information asymmetry to the minimum might exceed its benefit”. Managers of young and low-leverage restaurant businesses should be particularly wary of the dangers of too little disclosure. In addition, “managers’ decisions to disclose firm information should be based on the trade-off between the cost and benefit of information disclosure”, given that publicising information may harm competitiveness in the restaurant trade.
While previous studies have generally documented a simple negative linear relationship between information asymmetry and firm value, this important study shows that the situation can be more complex in specific sectors. Restaurant managers with an eye on stock value should not rush to share all. In an age when both voluntary and mandatory information disclosure are common, the study provides a useful reminder to practitioners that information transparency can be detrimental to certain firms in specific industries, while also setting the stage for more detailed research in this area.
About the authors
Gim, Jaehee, Jang, SooCheong (Shawn), Tang, Hugo, Choi, Kyuwan, and Behnke, Carl (2023). Is Information Asymmetry Always Detrimental to Firm Value? Findings from the Restaurant Industry. International Journal of Hospitality Management, Vol. 111, 103481.
