Higher Levels Of Information Asymmetry Research Articles

How do lending relationships affect access to credit and loan conditions in microlending?

A key problem facing microlenders is the high level of information asymmetry between them and their borrowers. In this paper, we analyze whether the relationship intensity between microlenders and borrowers helps to overcome existing information asymmetries and how this impacts access to credit and loan contract terms. Using a rich loan-level data set provided by a microlender in Mozambique for the years 2000–2006, we find that access to credit improves and that the loan approval process takes less time when relationships become more intense. Borrowers further profit from a more intense relationship through lower guarantee requirements. All effects are more pronounced the more opaque the borrowers are. These results suggest that longer lending relationships indeed help to reduce information asymmetries and that this is beneficial for microborrowers.

Entrepreneurial equity financing and securities regulation: An empirical analysis

To protect investors, securities regulation generally restrains entrepreneurial ventures from entering the stock market. Scholars and regulators contend that strong rules and requirements for listing are essential to prevent the market from failing. However, these constraints can also unduly impede the growth of new ventures. We use the Canadian case to examine the effects of the relaxation of the regulatory constraints. Unlike in other countries, firms in Canada can list at a very early stage, without revenues, with a minimal size and even without writing a prospectus using the reverse merger technique. This provides a unique opportunity to examine entrepreneurial ventures listed on a public market. The quality of firms, their post-listing operating performance and strategy, and their fate largely support the opinion that strong listing requirements are essential to prevent the emergence of a lemon market. Investors involved in this market obtain very poor returns. This indicates that they are neither able to set correct prices in this market nor deal with the high level of information asymmetry therein. The reluctance of most regulators to relax the requirements for small business finance can therefore, be justified.

Asymmetric Information and Conglomerate Discount: Evidence from Spinoffs

The existing literature argues that diversified firms may be undervalued due to the information asymmetry between a firm's management and the market. Splitting the firm's divisions into multiple business components is thought to facilitate the market valuation of each component more accurately. We investigate the information hypothesis from corporate spinoffs from 1981 through 2004. We use the post-spinoff data to reconstruct the diversified firm, assess the improvement in value at the combined firm level, and relate the value improvement to the change in the level of information asymmetry. We find that, prior to the spinoff, the sample firms have significantly higher levels of information asymmetry than their industry- and size-matched peers and that the level of information asymmetry decreases to a certain extent following the spinoff. We also find that the sample firms are valued at a substantial discount before the spinoff and that the valuation discount is eliminated after the completion of the spinoff. The matching firms, however, do not trade at a significant discount either pre- or post-spinoff. This is consistent with the view that only undervalued firms divest. More importantly, we find that the change in excess value around the spinoff is significantly and negatively related to the change in the level of information asymmetry. We conclude that information asymmetry is at least partly responsible for the diversification discount.

The Home Stigma: Adverse Selection in ADRs and the Home Capital Market Environment

We investigate whether characteristics of the home country capital market environment, such as information disclosure and investor rights protection, continue to affect ADRs cross-listed in the U.S. Using microstructure measures as proxies for adverse selection, we find that characteristics of the home markets continue to be relevant, especially for emerging market firms. Less transparent disclosure, poorer protection of investor rights, and weaker legal institutions are associated with higher levels of information asymmetry. Developed market firms appear to be affected by whether or not home business laws are of common law or civil law legal origin. To further understand the persistence of the home capital market effect, we find that regulatory effectiveness is an important determinant. The home capital market environment effect becomes weaker for emerging market firms after the enactment of the Sarbanes-Oxley Act. The bid-ask spread, as a measure of adverse-selection cost, increases two years into a cross-listing, and stays high for emerging market ADRs. Our finding contributes to the bonding literature. It suggests that cross-listing in the U.S. should not be viewed as a complete substitute for improvement in the quality of local institutions, and attention must be paid to improve investor protection in order to achieve the full benefit of improved disclosure. Improvement in the domestic capital market environment can attract more investors even for U.S. cross-listed firms. It also suggests that regulatory tightening in the U.S. has a bigger effect on emerging market ADRs than developed market ADRs.

Equity issues and temporal variation in information asymmetry

We investigate the intertemporal relation between information asymmetry and equity issues, and particularly focus on which firms drive this relation. We find that when information asymmetry for a particular firm is low compared to the recent past, the firm is more likely to issue equity as opposed to debt. Importantly, this intertemporal association is driven by firms with high levels of information asymmetry. These firms are more prone to adverse selection costs and thus have more to gain by issuing equity after a narrowing of the information gap between managers and investors. Our findings are robust to various firm-specific proxies for information asymmetry.

A Corporate Governance Explanation of the A-B Share Discount in China

B-shares listed in China are traded at substantial discounts to their corresponding A-shares although they have identical rights. We offer a governance explanation and suggest that relative to domestic investors, foreign investors care more about a firm’s governance quality. Results are supportive, as the B-share price discount is higher for firms that have weaker governance characterized by higher ownership concentration, ineffective boards with a higher proportion of directors appointed by the parent company, lower dividend payouts, and higher levels of information asymmetry. Interestingly, a tighter co-integration of A-B paired prices reduces the B-share discount, which also supports our governance explanation.

Information Asymmetry and Acquisition Premiums in Domestic and Cross Border M&As in Emerging Markets

In this paper, we test and find a strong positive relationship between information asymmetry and acquisition premium in the acquisitions of emerging market firms. The results are based on a large sample of domestic and cross-border acquisitions in 20 emerging countries between 1990 and 2007. We also confirm that under higher level of information asymmetry, acquiring firms tend to use lower cash payments (i.e., higher stock payments) and they are more likely to acquire majority control (>50%) in the target firms. After considering the endogenous relationship among acquisition premium, payment method, and majority control based on a simultaneous equation model, the positive relationship between asymmetric information and acquisition premium continues to exist. We also conduct various robustness tests with respect to the choice of information asymmetry proxy, estimation period and the correction of sample selection bias and find that the results do not change. We argue that acquiring firms pay high premium in order to gain majority control in the target firms to mitigate the information asymmetry problem and to access more valuable private information resources that are not accessible to public investors.

Timely Loss Recognition, Agency Costs, and the Cash Flow Sensitivity of Firm Investment

INTRODUCTION I examine whether timely loss recognition affects the sensitivity of firm investment to cash flows, a proxy for internal funds (see Hayashi, 1982). (1) Two related streams of literature motivate my analyses. First, timely loss recognition may arise not only out of a contracting need (Watts, 2003), but also out of the need to reduce information asymmetries between managers and investors (e.g. LaFond and Watts, 2008; Biddle et al., 2009). Where managers have significant information advantages over investors, timely loss recognition may act as a governance mechanism by resulting in a more conservative estimate of firm value. In line with this argument, timely loss recognition has been shown to be negatively related to cost of capital (e.g. Zhang, 2008; Lara et al., 2010), indicating investors consider conservative firms to be less risky. Second, financial reporting may have real effects in that managers take into account financial reporting practices when making operating and investment decisions (see Kanodia, 2007; McNichols and Stubben, 2009). Recent studies by Bushman et al. (2005), Ahmed and Duellman (2011), Francis and Martin (2009), and Lara et al. (2009) provide evidence that timely loss recognition improves capital allocation and investment profitability. Collectively, these findings support the argument by Ball (2001) and Ball and Shivakumar (2005) that conservative accounting forces managers to be mindful ex-ante of how they will report the outcomes of their investment decisions to investors ex-post. Given the potential for timely loss recognition to reduce external capital costs and affect managers' investment decisions, I examine its impact on one of the more established relations in the corporate finance literature, namely, the sensitivity of firm investment to cash flows. (2) Because of its ability to decrease external capital costs, timely loss recognition should be associated with a lower sensitivity of firm investment to cash flows. Furthermore, to the extent that timely loss recognition provides governance benefits, its impact on the investment-cash flow relation should be strongest in firms with a high agency costs (see LaFond and Watts, 2008; Francis and Martin, 2010). To test these predictions I expand the basic investment-cash flow model (e.g., Myers and Majluf, 1984; Gurgler et al., 2007; Chen et al., 2007) and examine whether the sensitivity of investment to cash flows is decreasing in timely loss recognition. I then introduce agency costs into the model to determine whether the impact of timely loss recognition on the investment-cash flow relation is dependent upon a firm's potential for agency problems. Results support my predictions; timely loss recognition is associated with a lower sensitivity of firm investment to cash flows, and this effect is strongest in firms with high agency costs. These findings are robust to both a changes specification of my primary empirical model and alternative measures of timely loss recognition. My study contributes to theory by Ball (2001) and Ball and Shivakumar (2005) that suggests conservative accounting has implications for corporate investment. I complement existing empirical studies by Ahmed and Duellman (2011) and Francis and Martin (2010) that find managers in firms with more timely loss recognition make better investments, and by Bushman et al. (2011) and Lara et al. (2010) which find that greater timely loss recognition improves capital allocation efficiency. My findings also add to the literature on the information benefits of conservative reporting. LaFond and Watts (2008) argue that timely loss recognition is most valuable in firms with high levels of information asymmetry. Francis and Martin (2010) lend empirical support to this argument by documenting that conservative firms make more profitable acquisitions, especially those firms with the potential for substantial agency problems. I provide additional support by documenting that firms with high agency costs benefit more from timely loss recognition in terms of their investment-cash flow sensitivity. …

The Prevalence and Underpinnings of Closing Price Manipulation

We empirically analyze the prevalence and economic underpinnings of closing price manipulation and its detection. We estimate that approximately one percent of closing prices are manipulated, of which only a small fraction is detected and prosecuted. We find that stocks with high levels of information asymmetry and mid to low levels of liquidity are most likely to be manipulated. A significant proportion of manipulation occurs on month/ quarter-end days. Manipulation on these days is more likely in stocks with high levels of institutional ownership. Government regulatory budget has a strong effect on both manipulation and detection.

Managerial motives for splitting stocks: Evidence from electric utility companies

Despite the rich literature on stock splits, studies have omitted public utility firms from their analysis when examining managerial motives for splitting stocks. In 1992 Congress enacted the Energy Policy Act (EPACT) to encourage the development of a competitive, national, wholesale electricity market. I argue that the change in the regulatory environment for public utilities provides a clean setting to study and compare the signaling and liquidity motivations for splitting stock. Before deregulation, the signaling motivation for splitting stocks is not applicable for these firms because the level of information asymmetry is low. Hence, the liquidity hypothesis should be the primary motivation for electric utilities to split stocks during this period. After deregulation, however, the signaling effect is expected to play a more dominant role because of higher level of information asymmetry. The results are consistent with the hypothesis posed. For the pre-EPACT period, liquidity motive seems to predominate in explaining the abnormal announcement return of utility stock splits. On the other hand, the results support the signaling motive as a leading explanation of abnormal returns in the post-EPACT period.

How Good are Private Equity Returns?

The authors examine the track record of private equity investments by looking at the results of recent research and then use new benchmarks to study the risk-adjusted returns of private equity investors. The authors give three reasons why it is difficult to measure private equity returns. First, market prices are typically old or not available and a high level of illiquidity is associated with the assets. Second, because of the high level of information asymmetry and the different skill levels of investors, returns to any one investor are not likely to be representative of returns across the private equity universe. Third, in spite of the dramatic growth in investment, there is still a limited history of returns.

THE ALLOCATION OF CONTROL RIGHTS IN FINANCING PRIVATE COMPANIES: VIEWS OF ESTONIAN PRIVATE EQUITY AND VENTURE CAPITALISTS

1. Introduction One common feature of high-growth companies is heavy reliance on external sources of financing. In current article, we analyze financing of private companies by private equity and venture capital. Young companies in emerging industries are characterized by a high level of economic and technological uncertainty, absence of credit history and collaterals and high level of information asymmetry, which prevents them of using more traditional sources of financing. Venture capital and private equity play a very important role in financing of these companies for that reason. As there is no easy way to exit investment, venture capitalists must ensure that their interests are well protected and that company is managed in best possible way. Therefore allocation of control rights is almost as important as allocation of cash flow rights in venture capital projects. Control issues are especially important in countries with a low level of investor protection or in countries, where principles of good corporate governance are not yet fully developed. According to empirical studies, interests of minority shareholders are relatively well protected in Estonia (see Pistor et al. 2000). However, enforcement of laws and regulations (effectiveness) in transition countries usually lag behind quality of law (extensiveness) (Pajuste 2002). Previous research has suggested that control issues are far more important in Estonia than in United States (Sander 2003). The aim of current article is to investigate allocation of control rights in private equity and venture capital projects in Estonia. Some organizational changes due to venture capitalist entrance to portfolio company are also indicated. A case study method is used and interviews are conducted to collect information about current practice of venture capital investments in Estonia. There are several similar studies conducted in developed countries (see e.g. Lehtonen 2000, Virtanen 1996). The situation in developing and transition countries has been less examined. The paper is structured as follows. The first section gives theoretical background. The second section describes research methodology and gives some background information about sample companies. Next section presents results of interviews with representatives of sample companies. The last section includes synthesis of theory and practice, as well as managerial implications. 2. Theoretical background Control rights have been defined by Tirole (2001) as the right for a player (or a group of players) to affect course of action once firm has gotten started (p13). The formal distribution of control rights is determined by nature of claims (debt, equity, or hybrid instrument), business laws (Commercial Code, Law of Obligations Act, Bankruptcy Code, etc.), companies' bylaws, and covenants associated with financial contracts and term sheets. However, as noted by Tirole (2001) players without formal control rights may actually enjoy substantial control over their organizations (for example large minority shareholder often decides for majority group of smaller ones, companies with diverse ownership are controlled by managers even if formal control belongs to shareholders, etc.). The choice of financing instrument is first aspect affecting allocation of control. Aghion and Bolton (1992) developed a theoretical model according to which choice of financial instrument should depend on which governance structure (entrepreneur control, contingent control, and investor control) is most effective. They suggested that control rights should belong to entrepreneurs, if such a governance structure is feasible. In this case company should be financed by using non-voting equity (preferred shares) (Ibid). In some countries (e.g. …

Equity Issues and Temporal Variation in Information Asymmetry

We investigate the intertemporal relation between information asymmetry and equity issues, and particularly focus on which firms drive this relation. We find that when information asymmetry for a particular firm is low compared to the recent past, the firm is more likely to issue equity as opposed to debt. Importantly, this intertemporal association is driven by firms with high levels of information asymmetry. These firms are more prone to adverse selection costs and thus have more to gain by issuing equity after a narrowing of the information gap between managers and investors. Our findings are robust to various firm-specific proxies for information asymmetry.

Accounting Numbers and Information Asymmetry: Evidence from Loss Firms

This paper studies whether firms reporting losses subsequently experience higher levels of information asymmetry among investors relative to firms reporting profits. Using bid-ask spreads as a measure of information asymmetry, I test whether loss firms have higher bid-ask spreads than profit firms after controlling for determinants of bid-ask spreads as identified by previous literature. I also differentiate between loss firms based on the history of losses and test whether multiple loss firms experience higher bid-ask spreads than single loss firms. The results show that, on average, loss firms have higher bid-ask spreads than profit firms and multiple loss firms have higher bid-ask spreads than single loss firms. Furthermore, the documented positive association between losses and bid-ask spreads is not driven by firms in financial distress. These results suggest that losses may affect the efficient functioning of capital markets through higher levels of information asymmetry.

Does Mandatory Disclosure Reduce the Cost of Capital? Evidence from Bonds

I examine whether the cost of debt is lower in states that have mandated the adoption of GAAP disclosure, compared to those with unregulated disclosure. I study municipal bond issuers because many states have unregulated disclosure, while others require GAAP, allowing an examination of the value of disclosure regulation in a relatively controlled experiment. Using a sample of municipal-level yield data, I find that mandatory disclosure is associated with a reduction of 15 basis points. Further, I find that the reduction in bond yields is the greatest among those organizations with relatively higher information asymmetry: those issuing unrated bonds, and small municipalities. In particular, unrated issues in GAAP states are associated with a yield reduction of 34 basis points, and small municipalities a yield reduction of 21 basis points. From this evidence, it is tempting to infer that municipalities benefit from mandatory disclosure, without consideration of the costs. However, prior research finds that the imposition of mandatory disclosure changes managers' use of alternate mechanisms, such as bond insurance, that also reduce the cost of debt. In further analysis, I find evidence consistent with regulation constraining the use of bond insurance among municipalities with relatively higher levels of information asymmetry. I conclude that disclosure regulation both provides benefits and imposes costs.

Does Information Asymmetry Explain The Diversification Discount?

AbstractWe examine the diversification discount while controlling for differences in information asymmetry between diversified and nondiversified firms. We show that both diversified and nondiversified firms with higher levels of information asymmetry have discounted firm values relative to firms with lower levels of information asymmetry, although a diversification discount remains at all levels of information asymmetry. Fixed‐effect Fama‐MacBeth regressions confirm the existence of a statistically significant relation between information asymmetry proxies and excess value, but they also show that a significant diversification discount remains after controlling for differences in information asymmetry and other firm characteristics discussed in earlier studies (e.g., size, profitability, leverage, and capital constraint).

The Role of Convertible Bonds in Alleviating Contracting Costs

We examine the impact of macroeconomic and firm-specific factors on the likelihood of issuance and the structure of convertible bonds. Consistent with convertibles mitigating financial distress and contracting costs, our results indicate that the likelihood of issuing convertible bonds compared to straight bonds is higher for smaller firms, high growth firms, firms with high levels of information asymmetry, and firms with high bankruptcy costs. We also find that firms are more likely to issue convertibles during periods of high interest rates, and during industry and economic downturns - periods when bankruptcy and financial distress costs are higher, and investment opportunities and agency problems deteriorate. When we examine the variation in the ex-ante probability of conversion of convertibles, we find that this probability is higher (i.e., convertible bonds are more equity-like) for smaller firms and during periods of high interest rates. Since financial distress costs are high in these cases, issuing equity-like convertibles allows firms to mitigate these costs by reducing their fixed claims. We also find that the convertibles are structured to be more equity-like in firms with low firm-specific information asymmetry, and during periods of high economic growth. Overall, convertible bonds provide firms an element of flexibility over straight bonds and equity that allow firms to mitigate financial distress and contracting costs of moral hazard and adverse selection, and raise capital even during unfavorable conditions. However, we find that financially constrained firms are less able to exploit the flexibility provided by convertibles as their need for capital overshadows all other concerns.

Investment Banker Reputation and the Performance of Seasoned Equity Issuers

We study the relation between investment banker reputation and announcement-period returns and between banker reputation and three-year post-issue holding-period returns for firms that conducted seasoned equity offerings (SEOs) between 1980 and 1994. We find a positive relation overall between investment banker reputation and announcement-period returns but no significant relation between investment banker reputation and long-run post-issue stock price performance. We also design an empirical model to predict the prestige of the issuer’s underwriter. We find that announcement-period returns are significantly related to banker prestige for issuers with high levels of information asymmetry that go against type to use a high-prestige investment banker.

Information asymmetry, valuation, and the corporate spin-off decision

We empirically analyze the information hypothesis that the separation of a firm's divisions into independently traded units through a spin-off enhances value because it mitigates information asymmetry about the firm. Consistent with this hypothesis, we find that firms that engage in spin-offs have higher levels of information asymmetry compared to their industry and size matched counterparts and the information problems decrease significantly after the spin-off. The gains around spin-offs are positively related to the degree of information asymmetry, and this relation is more pronounced for firms with fewer negative synergies between divisions. Finally, firms with higher growth opportunities and firms in need of external capital show a higher propensity to engage in spin-offs. They also raise more capital following a spin-off, which is consistent with the view that these firms mitigate information asymmetry before approaching the capital market for funds.

Information Asymmetry, Valuation, and the Corporate Spin-off Decision

We empirically analyze the information hypothesis that the separation of a firm's divisions into independently traded units through a spin-off is value enhancing because it mitigates information asymmetry about the firm. Consistent with this hypothesis, we find that firms that engage in spin-offs have higher levels of information asymmetry compared to their industry and size matched counterparts and the information problems decrease significantly after the spin-off. The gains around spin-offs are positively related to the degree of information asymmetry, and this relation is more pronounced for firms with less negative synergies between divisions. Finally, firms with higher growth opportunities and firms in need of external capital show a higher propensity to engage in spin-offs. They also raise more capital following a spin-off, which is consistent with the view that these firms mitigate information asymmetry before approaching the capital market for funds.