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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

The consequences of information differences across investors in capital markets are still much debated. This paper examines the relation between information differences across investors and the cost of capital, and makes three points. First, in models of perfect competition, information differences across investors affect a firm's cost of capital through investors' average information precision, and not information asymmetry per se. Second, the average precision effect of information that is heterogeneously distributed across investors is unlikely to diversify away when there exist many firms whose cash flows covary. Thus, better disclosure can reduce a firm's cost of capital. Third, the precision effect does not give rise to a separate information-risk factor. These points are important to empirical research in accounting and finance, as well as to regulators who debate future disclosure requirements and the consequences of prior requirements such as Regulation Fair Disclosure.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14881.

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Date of creation: Apr 2009
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Publication status: published as 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:nbr:nberwo:14881

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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. 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.
  3. James J. Choi & Li Jin & Hongjun Yan, 2013. "Informed Trading and Expected Returns," NBER Working Papers 18680, National Bureau of Economic Research, Inc.

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