When Does Information Asymmetry Affect the Cost of Capital?

Journal of Accounting Research, Forthcoming

56 Pages Posted: 25 Oct 2010 Last revised: 9 Mar 2015

Chris Armstrong

University of Pennsylvania - Accounting Department

John E. Core

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Daniel J. Taylor

University of Pennsylvania - The Wharton School

Robert E. Verrecchia

University of Pennsylvania - Accounting Department

Date Written: October 24, 2010

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.

Keywords: information asymmetry, cost of capital, market competition, expected returns

Suggested Citation

Armstrong, Chris and Core, John E. and Taylor, Daniel J. and Verrecchia, Robert E., When Does Information Asymmetry Affect the Cost of Capital? (October 24, 2010). Journal of Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1697344

Chris S. Armstrong

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

John E. Core (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

77 Massachusetts Ave.
E62-416
Cambridge, MA 02138
United States

Daniel Taylor

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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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