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When Does Information Asymmetry Affect the Cost of Capital?


  • We gratefully acknowledge the comments of Ray Ball (editor), Itzhak Ben-David, Sanjeev Bhojraj, Christine Botosan (2009 AAA discussant), Brian Bushee, Wayne Guay, Kewei Hou, Rick Lambert, Christian Leuz, Heather Tookes, an anonymous referee, and seminar participants at the 2009 American Accounting Association meetings, Cornell University, The Ohio State University, the Wharton School, and Yale University. We gratefully acknowledge the financial support of the Sloan School of Management and of the Wharton School. Christopher Armstrong is grateful for financial support from the Dorinda and Mark Winkelman Distinguished Scholar Award. Daniel Taylor also gratefully acknowledges funding from the Deloitte Foundation. We thank Rahul Vashishtha and Yuxing Yan for programming assistance.


This paper examines when information asymmetry among investors affects the cost of capital in excess of standard risk factors. When equity markets are perfectly competitive, information asymmetry has no separate effect on the cost of capital. When markets are imperfect, information asymmetry can have a separate effect on firms’ cost of capital. Consistent with our prediction, we find that information asymmetry has a positive relation with firms’ cost of capital in excess of standard risk factors when markets are imperfect and no relation when markets approximate perfect competition. Overall, our results show that the degree of market competition is an important conditioning variable to consider when examining the relation between information asymmetry and cost of capital.