Disclosure, Liquidity, and the Cost of Capital




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    • The University of Chicago and the University of Pennsylvania, respectively. Diamond gratefully acknowledges support from NSF grant SES-8896223 and from a gift to the University of Chicago from Dimensional Fund Advisors. Verrecchia gratefully acknowledges financial assistance from Ernst & Young and the Wharton School of the University of Pennsylvania. We are grateful to Franklin Allen, René Stulz, Robert Vishny, an anonymous referee, and workshop participants at the University of Chicago, the Federal Reserve Bank of Richmond, Georgetown University, and UCLA for helpful comments on a previous draft.


This paper shows that revealing public information to reduce information asymmetry can reduce a firm's cost of capital by attracting increased demand from large investors due to increased liquidity of its securities. Large firms will disclose more information since they benefit most. Disclosure also reduces the risk bearing capacity available through market makers. If initial information asymmetry is large, reducing it will increase the current price of the security. However, the maximum current price occurs with some asymmetry of information: further reduction of information asymmetry accentuates the undesirable effects of exit from market making.