Information Asymmetry, Information Precision, and the Cost of Capital
Review of Finance, Forthcoming
Posted: 26 Apr 2011
Date Written: April 25, 2011
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: Suggested Citation