INFORMATION ASYMMETRY AND COST OF CAPITAL: A REVIEW OF EMPIRICAL EVIDENCE

Abstract

This paper reviewed relevant empirical studies that examined the effect of information asymmetry (IA) on corporate cost of capital (COC) over seventeen years (2007 -2023). Critical/integrative review approach was adopted and the paper found that results obtained by the reviewed studies regarding the impact of IA on COE or WACC are in two sets: positive and negative. However, most of them have agreed and corroborated one another on the positive effect of IA on COE or WACC. And, this goes in line with the basic argument of the pecking order theory in its first proposition. Also, regarding IA and COD, the reviewed studies have agreed that IA positively affects COD. Other findings of the paper are that most of the reviewed studies were carried out in Asia, focusing on non-financial firms. Moreover, most of the studies assessed IA's effect on COE by employing Bid-ask spread and Eastos's (2004) PEG ratio models as common measures. Based on the summary of major findings, the paper concluded that corporate firms will be experiencing a rise in financing cost as long as there is an increase in asymmetric information in the capital market. The increase will affect equity financing, debt financing and overall financing costs. Thus, in line with the conclusions drawn, the paper recommended that corporate firms should strive to minimize the level of IA in the capital market through a commitment to providing high-quality financial reports that furnish the capital providers with relevant, reliable and comprehensive information.

Keywords

• Information Asymmetry
• Adverse Selection
• Moral Hazard
• Cost of Equity
• Cost of Debt
• Weighted Average Cost of Capital