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
Date Written: October 24, 2010
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
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