When Does Information Asymmetry Affect the Cost of Capital?

John E. Core · Daniel J. Taylor · Robert E. Verrecchia

492 citations0/0 files storedJournal of Accounting Research

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Corporate Finance and Governance Financial Markets and Investment Strategies Auditing, Earnings Management, Governance

Abstract

ABSTRACT This paper examines when information asymmetry among investors affects the cost of capital in excess of standard risk factors. When equity markets are perfectly competitive, information asymmetry has no separate effect on the cost of capital. When markets are imperfect, information asymmetry can have a separate effect on firms’ cost of capital. Consistent with our prediction, we find that information asymmetry has a positive relation with firms’ cost of capital in excess of standard risk factors when markets are imperfect and no relation when markets approximate perfect competition. Overall, our results show that the degree of market competition is an important conditioning variable to consider when examining the relation between information asymmetry and cost of capital.

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References

1993Common risk factors in the returns on stocks and bonds 1997On Persistence in Mutual Fund Performance 2003Corporate Governance and Equity Prices 1987A Simple Model of Capital Market Equilibrium with Incomplete Information 2003Liquidity Risk and Expected Stock Returns 2002The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors 1986Asset pricing and the bid-ask spread 2006The Cross‐Section of Volatility and Expected Returns

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2011Information Asymmetry, Information Precision, and the Cost of Capital 2014Linguistic Complexity in Firm Disclosures: Obfuscation or Information?2014Do independent directors cause improvements in firm transparency?2013The Effect of Corporate Tax Avoidance on the Cost of Equity 2012Does Earnings Quality Affect Information Asymmetry? Evidence from Trading Costs*2014The Media and Mispricing: The Role of the Business Press in the Pricing of Accounting Information

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