Information asymmetry and the cost of equity capital

William Peng He, Andrew Lepone*, Henry Leung

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

31 Citations (Scopus)

Abstract

This study examines the relation between information asymmetry and the cost of equity capital of firms listed on the Australian Securities Exchange. We calculate the ex ante cost of equity capital for constituent companies of the S&P/ASX 200 Index. The bid-ask spread of the companies is decomposed to find the adverse selection component, which is used to measure the information asymmetry of the company. We control for factors generally known to influence the required return on equity, such as sector, beta, firm size, book-to-market, analyst coverage and analyst earnings forecast dispersion. This study documents a significant and positive relation between information asymmetry and ex ante investor's required rate of return. We also find that earnings forecast dispersion increases ex ante cost of equity capital, while analyst coverage tends to decrease the return required by investors. This is consistent with the expectation that cost of capital increases with higher levels of information uncertainty and asymmetry.

Original languageEnglish
Pages (from-to)611-620
Number of pages10
JournalInternational Review of Economics and Finance
Volume27
DOIs
Publication statusPublished - Jun 2013
Externally publishedYes

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