“The Impact of Competition on Firm Transparency: A Study of Inflation Pass-Through” by Dr. Jin XIE
Dr. Jin XIE
School of Accountancy
CUHK Business School
The Chinese University of Hong Kong
This paper provides first evidence that product market competition in an inflationary environment suppresses the revelation of firms’ private information about production costs, which in turn exacerbates adverse selection in the financial market. Using detailed industry-level data from the Bureau of Labor Statistics (BLS), we develop a novel measure of the extent to which product prices will be adjusted in response to inflation shocks to input costs. We document two stylized facts based on this measure. First, competitive industries are much less flexible than monopolistic industries to pass inflation on to customers. Second, the sluggishness of inflation pass-through significantly increases the information asymmetry between firms and outside investors, which is measured by a battery of proxies. These proxies include the dispersion of analyst forecasts, the informativeness of accounting information, borrowers’ reliance on informed debt financing, and the strictness of initial loan covenants. A multi-period model with both time- and state- dependent price adjustments is consistent with our findings.