Information Asymmetry, Information Precision, and the Cost of Capital

44 Pages Posted: 20 Apr 2009  

Richard A. Lambert

University of Pennsylvania - Accounting Department

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network

Robert E. Verrecchia

University of Pennsylvania - Accounting Department

Multiple version iconThere are 3 versions of this paper

Date Written: April 2009

Abstract

The consequences of information differences across investors in capital markets are still much debated. This paper examines the relation between information differences across investors and the cost of capital, and makes three points. First, in models of perfect competition, information differences across investors affect a firm's cost of capital through investors' average information precision, and not information asymmetry per se. Second, the average precision effect of information that is heterogeneously distributed across investors is unlikely to diversify away when there exist many firms whose cash flows covary. Thus, better disclosure can reduce a firm's cost of capital. Third, the precision effect does not give rise to a separate information-risk factor. These points are important to empirical research in accounting and finance, as well as to regulators who debate future disclosure requirements and the consequences of prior requirements such as Regulation Fair Disclosure.

Suggested Citation

Lambert, Richard A. and Leuz, Christian and Verrecchia, Robert E., Information Asymmetry, Information Precision, and the Cost of Capital (April 2009). NBER Working Paper No. w14881. Available at SSRN: https://ssrn.com/abstract=1391828

Richard Lambert

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
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Christian Leuz (Contact Author)

University of Chicago - Booth School of Business ( email )

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HOME PAGE: http://faculty.chicagobooth.edu/christian.leuz/

National Bureau of Economic Research (NBER) ( email )

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HOME PAGE: http://www.nber.org

European Corporate Governance Institute (ECGI)

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Belgium

HOME PAGE: http://www.ecgi.org

Center for Financial Studies (CFS) ( email )

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Frankfurt am Main, 60323
Germany

University of Pennsylvania - Wharton Financial Institutions Center

3641 Locust Walk
Philadelphia, PA 19104-6218
United States

CESifo Research Network

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Munich, DE-81679
Germany

Robert E. Verrecchia

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6976 (Phone)
215-573-2054 (Fax)

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