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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.

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Bibliographic Info

Article provided by European Finance Association in its journal Review of Finance.

Volume (Year): 16 (2011)
Issue (Month): 1 ()
Pages: 1-29

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Handle: RePEc:oup:revfin:v:16:y:2011:i:1:p:1-29

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Cited by:
  1. Gao, Pingyang, 2008. "Disclosure Quality, Cost of Capital, and Investors’ Welfare," MPRA Paper 9478, University Library of Munich, Germany, revised Jun 2008.
  2. James J. Choi & Li Jin & Hongjun Yan, 2013. "Informed Trading and Expected Returns," NBER Working Papers 18680, National Bureau of Economic Research, Inc.
  3. Bruno Maria Parigi & Loriana Pelizzon & Ernst-Ludwig von Thadden, 2013. "Stock Market Returns, Corporate Governance and Capital Market Equilibrium," CESifo Working Paper Series 4496, CESifo Group Munich.

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