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Information Asymmetry, Information Precision, and the Cost of Capital

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  • Richard A. Lambert
  • Christian Leuz
  • Robert E. Verrecchia

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. Copyright 2011, Oxford University Press.

Suggested Citation

  • Richard A. Lambert & Christian Leuz & Robert E. Verrecchia, 2011. "Information Asymmetry, Information Precision, and the Cost of Capital," Review of Finance, European Finance Association, vol. 16(1), pages 1-29.
    • Handle: RePEc:oup:revfin:v:16:y:2011:i:1:p:1-29
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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