When Does Information Asymmetry Affect the Cost of Capital?

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.     

Competitive Pricing in Markets with Different Overhead Costs: Concealment or Leakage of Cost Information?

This paper experimentally investigates how leaders and followers in a duopoly set prices for two product markets that have different overhead costs. In a fully crossed two-by-two design, we manipulate the participants' private cost report quality as either low or high, representing the extent to which these reports reveal that product markets have different overhead costs. We show that when only the leader is given a high-quality cost report, private cost information of higher quality is better incorporated into market prices (that are observable to participants). Both the leader and follower improve in profits and their prices better reflect the differences in overhead costs because the follower infers information from the leader's prices (information leakage). In contrast, when only the follower receives a high-quality cost report, the leader's profits and prices do not improve. This occurs because the follower conceals cost information when the leader has a low-quality cost report.     

Option trading: Information or differences of opinion?

This paper investigates the motive of option trading. We show that option trading is mostly driven by differences of opinion, a finding different from the current literature that attempts to attribute option trading to information asymmetry. Our conclusion is based on three pieces of empirical evidence. First, option trading around earnings announcements is speculative in nature and mostly dominated by small, retail investors. Second, around earnings announcements, the pre-announcement abnormal turnovers of options seem to predict the post-announcement abnormal stock returns. However, once we control for the pre-announcement stock returns, the predictability completely disappears, implying that option traders simply take cues from the stock market and turn around to speculate in the options market. Third, cross-section and time-series regressions reveal that option trading is also significantly explained by differences of opinion. While informed trading is present in stocks, it is not detected in options.     

Venture Capital Valuation,Partial Adjustment,and Underpricing: Behavioral Bias or Information Production?

Using a sample of venture capital (VC)‐backed initial public offerings (IPOs), we analyze the role played by perceived valuation changes on IPO underpricing. We find that perceived valuation change from the last pre‐IPO VC round to the IPO affects IPO underpricing in a nonlinear way. Further analysis indicates that information‐based theories, not behavioral biases, explain this nonlinearity. We also find that the previously documented partial adjustment effect and its nonlinear impact on IPO underpricing are related to the trajectory of the perceived valuation changes, which stands in stark contrast to prior evidence of the importance of behavioral biases.     

Information content of repurchase signals: Tangible or intangible information?

The outperformance of repurchasing firms with a high book-to-market (B/M) ratio is usually explained by investors’ undervaluation of the firm’s past performance. However, several studies suggest that the underestimation of future intangible value may explain the high return associated with the share repurchase. To better understand the actual information content of repurchases, I decompose the B/M ratio into past tangible information and future intangible information and find that repurchase signals an undervaluation of the intangible return. In addition, I investigate several potential proxies for intangible information—R&D expenses, intangible assets, and future operating performance. My results show that intangible information signals the undervaluation of future operating performance.     

Discussion of “The Effects of Taxes,Agency Costs and Information Asymmetry on Earnings Management: A Comparison of Public and Private Firms”

Review of Accounting Studies -     

Does Anticipated Information Impose a Cost on Risk‐Averse Investors? A Test of the Hirshleifer Effect

This paper theoretically and empirically investigates how the risk of future adverse price changes created by the anticipated arrival of information influences risk‐averse investors’ trading decisions in institutionally imperfect capital markets. Specifically, I examine how the selling activity of individual investors immediately following an earnings announcement is influenced by the tradeoff between risk‐sharing benefits of immediate trade and explicit transaction costs imposed on such trades. Consistent with my theoretically derived predictions, I find that investors’ current trading decisions are less sensitive to the incremental transaction costs created by short‐term capital gains taxes on trading profits, as both the duration and intensity of the risk of future adverse price changes increase. This evidence is consistent with an incremental cost to investors that results from the revelation of precise information, which is commonly referred to as the Hirshleifer Effect.     

Price Discovery for Segmented US-Listed Chinese Stocks: Location or Market Quality?

Abstract:  This study extends the cross-listing literature by examining how, and to what extent, the trading of cross-listed China-backed ADRs on the New York Stock Exchange contributes to information flows and price discovery for the corresponding stocks traded in China's A-share market. We find that the cross-listed US prices and Chinese prices are not cointegrated in the long-run and the home market plays a far more important role in both price discovery and volatility spillover than does the US market. The home bias hypothesis still holds for the segmented Chinese A-share market and the location where price discovery actually originates is the essential factor in the process of international information transmission.     

Information interpretation or information discovery: which role of analysts do investors value more?

This study provides evidence that a significant percentage of analyst forecast revisions are issued promptly after a broad set of corporate public disclosures and that investors perceive these prompt revisions as more valuable than nonprompt revisions. These results hold for all revisions, revisions outside of the earnings announcement window, or revisions in weeks preceding the earnings announcements and are also robust to various sensitivity tests. Investors particularly value analysts?? prompt interpretation of earnings announcements, Form 8-K filings, or certain qualitative news. To the extent that prompt revisions are more likely to reflect analysts?? information interpretation role, our results suggest that investors value more highly analysts?? ability to interpret public disclosures, especially less structured or non-financial disclosures, than their ability for information discovery.     

The Declining Credit Quality of U.S. Corporate Debt: Myth or Reality?

In recent years, the number of downgrades in corporate bond ratings has exceeded the number of upgrades, leading some to conclude that the credit quality of U.S. corporate debt has declined. However, an alternative explanation of this apparent decline in credit quality is that the rating agencies are now using more stringent standards in assigning ratings. An ordered probit analysis of a panel of firms from 1978 through 1995 suggests that rating standards have indeed become more stringent, implying that at least part of the downward trend in ratings is the result of changing standards.     

What Drives the Issuance of Putable Convertibles: Risk-Shifting,Asymmetric Information,or Taxes?

This paper presents the first empirical analysis of firms’ rationale for issuing putable convertible bonds in the literature. We distinguish between three possible rationales for the issuance of putable convertibles: 1) the risk-shifting hypothesis, 2) the asymmetric information hypothesis, and 3) the tax savings hypothesis. The results of our empirical analysis can be summarized as follows. First, putable convertible issuers are larger, less risky firms, having larger cash flows, smaller growth opportunities, and lower bankruptcy probabilities as compared to ordinary convertible issuers. Second, putable convertible issuers have lower preissue market valuations, more favorable announcement effects, and better postissue operating performance when compared to ordinary convertible issuers. Third, putable convertible issuers have better postissue long-run stock return performance as compared to ordinary convertible issuers. Finally, putable convertible issuers typically have greater tax obligations and better credit ratings than ordinary convertible issuers. Overall, the results of our univariate as well as multivariate analyses provide support for the asymmetric information and tax savings hypotheses, but little support for the risk-shifting hypothesis.     

IPO or SBO?: The Increasing Importance of Operational Performance for Private Equity Exits Following the Global Financial Crisis of 2007–08

The authors report the findings of their recent study of the role of portfolio company operating performance in determining the choice of exit options by private equity firms between initial public offerings (IPOs) and secondary buyouts (SBOs), and how that role may have changed since the Global Financial Crisis of 2007–2008. Virtually all studies of PE exits in all countries have found that portfolio companies that exit through IPOs tend to be larger and have higher operating returns than companies that exit through SBOs or sales to other companies. After examining the exits of PE portfolio companies based in Denmark and Sweden during the period 2003–2013, the authors report that, although general market conditions continue to be a major factor, operating performance and size have become even more important requirements for IPO exits since the crisis. And thus PE firms that fail to make operating improvements in their portfolio companies are likely to find their exit options limited.     

Emerging from Chapter 11 Bankruptcy: Is It Good News or Bad News for Industry Competitors?

A firm under Chapter 11 bankruptcy protection may emerge from bankruptcy in a more advantageous competitive position within its industry to the detriment of their industry rivals. Using a sample of 264 firms that emerged from Chapter 11 bankruptcy during the period 1999-2006, I find that its industry competitors demonstrate negative postemergence long-term equity returns and deteriorating financial performance. Additional tests indicate that this outcome is less likely due to overall industry distress. Competitors tend to be more adversely affected if they are in more concentrated industries, if they have lower credit quality, when a more efficient firm emerges, and when the duration of bankruptcy is longer. This study suggests a need to reconsider Chapter 11's role in promoting competition and allocation of resources given its negative externalities on industry competitors.     

A critical financial analysis of the Private Finance Initiative: selecting a financing method or allocating economic wealth?

The UK government’s Private Finance Initiative (PFI) policy raises a series of questions about the rationality and distributive implications of using private finance, inevitably more expensive than public finance, in essential public services. This paper, by examining the process, the financial methodology, its assumptions and the data used in the system of appraisal for new hospital builds under PFI, shows that the decisions rested upon the ambiguous concepts of risk transfer and value for money at the level of the individual hospital rather than the system or society as a whole. These concepts were far from neutral and provided the rationalising motif for a process that transfers resources from the public at large to the financial elite, thereby obscuring the distribution issues that were largely missing from the policy debate.     

On Stable Factor Structures in the Pricing of Risk: Do Time-Varying Betas Help or Hurt?

There is now considerable evidence suggesting that estimated betas of unconditional capital asset pricing models (CAPMs) exhibit statistically significant time variation. Therefore, many have advocated the use of conditional CAPMs. If we succeed in capturing the dynamics of beta risk, we are sure to outperform constant beta models. However, if the beta risk is inherently misspecified, there is a real possibility that we commit serious pricing errors, potentially larger than with a constant traditional beta model. In this paper we show that this is indeed the case, namely that pricing errors with constant traditional beta models are smaller than with conditional CAPMs.     

Stock Return Predictability of Residual‐Income‐Based Valuation: Risk or Mispricing?

In an influential paper, Frankel and Lee (1998) conclude that the stock return predictability of the value‐to‐price ratio (V/P) results from market mispricing. This paper confirms whether the V/P reflects the rational risk premiums associated with the V/P factor or is better explained by market inefficiency. Following Daniel and Titman (1997), this paper examines whether the V/P characteristics or the V/P factor loadings predict stock returns. The findings show that the V/P loadings are positively associated with average returns even after controlling for the V/P characteristics in both time series and cross‐sectional tests. The overall results suggest that the mispricing explanation of the V/P effect is premature.     

What determines the financing decision in corporate takeovers: Cost of capital,agency problems,or the means of payment?

How is a takeover bid financed and what is its impact on the expected value creation of the takeover? An analysis of the sources of transaction financing has been largely ignored in the takeover literature. Using a unique dataset, we show that external sources of financing (debt and equity) are frequently employed in takeovers involving cash payments. Acquisitions with the same means of payment but different sources of transaction funding are in fact quite distinct. Acquisitions financed with internally generated funds significantly underperform those financed with debt. The takeover financing decision is influenced by the bidder's pecking order preferences, its growth potential, and its corporate governance environment, all of which are related to the cost of external capital. The choice of equity versus internal cash or debt financing also depends on the bidder's strategic preferences with respect to the means of payment.