Information Asymmetry, Information Precision, and the Cost of Capital

Review of Finance, Forthcoming

Posted: 26 Apr 2011  

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 25, 2011

Abstract

This paper examines the relation between information differences across investors (i.e., information asymmetry) and the cost of capital, and establishes that with perfect competition information asymmetry makes no difference. Instead, a firm’s cost of capital is governed solely by the average precision of investors’ information. With imperfect competition, however, information asymmetry affects the cost of capital even after controlling for investors’ average precision. In other words, the capital market’s degree of competition plays a critical role for the relation between information asymmetry and the cost of capital. This point is important to empirical research in finance and accounting.

Keywords: Cost of Capital, Information Asymmetry, Imperfect Competition

JEL Classification: G12, G14, G31, M41

Suggested Citation

Lambert, Richard A. and Leuz, Christian and Verrecchia, Robert E., Information Asymmetry, Information Precision, and the Cost of Capital (April 25, 2011). Review of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1822848

Richard Lambert

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-7782 (Phone)
215-573-5463 (Fax)

Christian Leuz (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-1996 (Phone)

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

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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

European Corporate Governance Institute (ECGI)

Brussels
Belgium

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

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

University of Pennsylvania - Wharton Financial Institutions Center

3641 Locust Walk
Philadelphia, PA 19104-6218
United States

CESifo Research Network

Poschinger Str. 5
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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