Institutional Investors, Private Information, and the Cost of Capital

Abstract

We study the relation between institutional shareholdings, private information in stock prices and the cost of capital. Using the probability of informed trading as a proxy for private information, we find that institutional ownership reduces private information in stock prices, and firms with high private information faces a higher cost of capital compared to those with low private information. More importantly, we find that the effect of private information on the cost of capital becomes insignificant for firms that have high institutional ownership. Our findings imply that investors do not require a higher rate of risk-adjusted return for private information risks when holding stocks of firms with high institutional ownership.