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Information Environment and the Cost of Capital: A New Approach

  • Xuguang Sheng
  • Orie Barron
  • Maya Thevenot

Sheng and Thevenot (2011) develop a new measure of uncertainty which is a modification of the uncertainty measure advanced by Barron, Kim, Lim and Stevens (BKLS 1998), and they find this new uncertainty measure to be superior to the BKLS measure in certain settings. We follow Sheng and Thevenot's suggestion for modifying other measures of the information environment, and we demonstrate that our new measures are superior in another setting. We also find that cost of equity capital increases greatly with our new measures of information asymmetry and average information precision even after controlling for the level of market competition. Our regression estimates suggest that information asymmetry and average information precision are more important factors than equity beta and firm size in determining firms' cost of capital, and that the seemingly great importance of these new measures is not apparent using the prior BKLS measures of information asymmetry and precision.

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File URL: http://www.american.edu/cas/economics/research/upload/2012-12.pdf
File Function: First version, 2012
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Paper provided by American University, Department of Economics in its series Working Papers with number 2012-12.

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Date of creation: 2012
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Handle: RePEc:amu:wpaper:2012-12
Contact details of provider: Web page: http://www.american.edu/cas/economics/

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  1. Christopher S. Armstrong & John E. Core & Daniel J. Taylor & Robert E. Verrecchia, 2011. "When Does Information Asymmetry Affect the Cost of Capital?," Journal of Accounting Research, Wiley Blackwell, vol. 49(1), pages 1-40, 03.
  2. Barth, Mary E. & Konchitchki, Yaniv & Landsman, Wayne R., 2013. "Cost of capital and earnings transparency," Journal of Accounting and Economics, Elsevier, vol. 55(2), pages 206-224.
  3. Sheng, Xuguang & Thevenot, Maya, 2012. "A new measure of earnings forecast uncertainty," Journal of Accounting and Economics, Elsevier, vol. 53(1), pages 21-33.
  4. Diamond, Douglas W & Verrecchia, Robert E, 1991. " Disclosure, Liquidity, and the Cost of Capital," Journal of Finance, American Finance Association, vol. 46(4), pages 1325-59, September.
  5. David Easley & Maureen O'hara, 2004. "Information and the Cost of Capital," Journal of Finance, American Finance Association, vol. 59(4), pages 1553-1583, 08.
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