When Does Information Asymmetry Affect the Cost of Capital?

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 hav...

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Bibliographic Details
Published in:Journal of accounting research 2011-03, Vol.49 (1), p.1-40
Main Authors: ARMSTRONG, CHRISTOPHER S., CORE, JOHN E., TAYLOR, DANIEL J., VERRECCHIA, ROBERT E.
Format: Article
Language:English
Subjects:
Asymmetric information
Asymmetry
Capital costs
Capital markets
competition
Expected returns
Financial analysis
Financial information
Financial portfolios
Financing methods
Information asymmetry
Information sharing
Investors
Market competition
Proxy reporting
Proxy statements
Risk assessment
Risk factors
Shareholders
Studies
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Summary: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.
ISSN:0021-8456
1475-679X
DOI:10.1111/j.1475-679X.2010.00391.x