Working Paper: NBER ID: w14881
Authors: 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.
Keywords: Information Asymmetry; Cost of Capital; Disclosure
JEL Codes: G12; G14; G31; M41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| average precision of information (D83) | cost of capital (G31) |
| better disclosure practices (G38) | average precision of information (D83) |
| information asymmetry (D82) | cost of capital (G31) |
| average precision of information (D83) | risk premium associated with holding shares (G12) |