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This paper empirically tests Kim and Verrecchia's (1994, hereafter KV) theory that bid-ask spreads may increase around earnings announcements when information asymmetry increases between the informed traders and the less informed market-makers. Despite certain limitations, prior research has used analysts' earnings forecasts as a proxy for information asymmetry. I substitute the percentage of common stocks held by institutional investors as a more precise proxy for information asymmetry. Consistent with KV's proposition, I find (1) that bid-ask spreads increase at the time of earnings announcements, and (2) that bid-ask reactions to earnings announcements are significantly positively related to information asymmetry even after controlling for the effects of other cross-sectional determinants of spreads.

There is a growing belief that historical-cost accounting is no longer a relevant or reliable means of valuing a firm's assets and liabilities. Economists consider economic income relevant for measuring profit and performance, while they consider accounting income misleading for these purposes. The critical issue of measuring economic income has received little attention. The purpose of this paper is to point out some of the problems involved in computing economic income and to present ways in which accounting income can be adjusted to make it a more viable measurement.