We examine the association between the cost of equity capital and the quality of public and private information. We find an inverse relationship between the cost of capital and the precision of public information, but the effect is more than offset by a positive relationship between the cost of equity capital and the precision of private information. Public and private information precisions are positively correlated, and a model that fails to include both is vulnerable to a correlated omitted variable bias. The association between public and private information combined with their opposing effects on the cost of capital implies mangers should consider the relationship between public and private information when assessing their reporting strategy.
This is a preview of subscription content, access via your institution.
Buy single article
Instant access to the full article PDF.
Price includes VAT (USA)
Tax calculation will be finalised during checkout.
Abarbanell, J. and V. L. Bernard. (2000). “Is the US Stock Market Myopic?” Journal of Accounting Research 38, 221–242.
Admati, A. (1985). “A Noisy Rational Expectations Equilibrium for Multi-Asset Securities Markets.” Econometrica 53, 629–658.
Alles, M. and R. Lundholm. (1993). “On the Optimality of Public Signals in the Presence of Private Information.” The Accounting Review 68, 89–92.
Amihud, Y. (2000). “Illiquidity and Stock Returns: Cross-Sectional and Time Series Effects.” Working paper, New York University.
Amihud, Y. and H. Mendelson. (1986). “Asset Pricing and the Bid-Ask Spread.” Journal of Financial Economics 17, 223–249.
Amihud, Y. and H. Mendelson. (1988). “Liquidity and Asset Prices: Financial Management Implications.” Financial Management 17, 5–15.
Amihud, Y. and H. Mendelson. (1989). “The Effects of Beta, Bid-Ask Spread, Residual Risk and Size on Stock Returns.” Journal of Finance 44, 479–486.
Barron, O., D. Byard and O. Kim. (2002). “Changes in Analysts' Information Around Earnings Announcements.” The Accounting Review 77, 821–846.
Barron, O., D. Harris and M. Stanford. (2003). “Evidence on the Existence of Private Event-Period Information Around Earnings Announcements.” Working paper, Pennsylvania State University.
Barron, O., C. Kile and T. O'Keefe. (1999). “MD&;A Quality as Measured by the SEC.” Contemporary Accounting Research 16, 75–110.
Barron, O., O. Kim, S. Lim and D. Stevens. (1998). “Using Analysts' Forecasts to Measure Properties of Analysts' Information Environment.” The Accounting Review 73, 421–433.
Barry, C. and S. Brown. (1985). “Differential Information and Security Market Equilibrium.” Journal of Financial and Quantitative Analysis 20, 407–422.
Beaver, W., P. Kettler and M. Scholes. (1970). “The Association Between Market Determined and Accounting Determined Risk Measures.” The Accounting Review 45, 654–681.
Berk, J. (1995). “A Critique of Size-Related Anomalies.” Review of Financial Studies 8, 275–286.
Botosan, C. (1997). “Disclosure Level and the Cost of Equity Capital.” The Accounting Review 72, 323–349.
Botosan, C. and M. Harris. (2000). “The Cross-Sectional Determinants of Disclosure Timeliness: An Examination of Quarterly Segment Disclosures.” Journal of Accounting Research 38, 524–554.
Botosan, C. and M. Plumlee. (2002). “A Re-Examination of Disclosure Level and the Expected Cost of Equity Capital.” Journal of Accounting Research 40, 21–40.
Botosan, C. and M. Plumlee. (2003a). “Assessing Alternative Proxies for the Expected Risk Premium.” Working paper, University of Utah.
Botosan, C. and M. Plumlee. (2003b). “Are Information Attributes Priced?” Working paper, University of Utah.
Botosan, C. and M. Stanford. (2003). “An Empirical Examination of the Costs and Benefits of SFAS 131: Disclosures About Segments of an Enterprise and Related Information.” Working paper, University of Utah.
Brennan, M. and A. Subrahmanyam. (1996). “Market Microstructure and Asset Pricing: On the Compensation for Illiquidity in Stock Returns.” Journal of Financial Economics 41, 441–464.
Brown, S., M. Finn and S. Hillegeist. (2001). “Disclosure Quality and the Probability of an Informed Trade.” Working paper, Northwestern University.
Bushman, R. (1991). “Public Information and the Structure of Private Information Markets.” Journal of Accounting Research 29, 261–276.
Byard, D. (2001). “Firm Size and Analyst Forecasts.” Working paper, University of Cincinnati.
Byard, D. and K. Shaw. (2002). “Corporate Disclosure Quality and Properties of Analysts' Information Environment.” Working paper, University of Missouri.
Clarkson, P., J. Guedes and R. Thompson. (1996). “On the Diversification, Observability, and Measurement of Estimation Risk.” Journal of Financial and Quantitative Analysis 31, 69–84.
Coles, J. and U. Loewenstein. (1988). “Equilibrium Pricing and Portfolio Composition in the Presence of Uncertain Parameters.” Journal of Financial Economics 22, 279–303.
Coles, J., U. Loewenstein and J. Suay. (1995). “On Equilibrium Pricing Under Parameter Uncertainty.” Journal of Financial and Quantitative Analysis 30, 347–364.
Coller, M. and T. Yohn. (1997). “Management Forecasts and Information Asymmetry: An Examination of Bid-Ask Spreads.” Journal of Accounting Research 35, 181–192.
Copeland, T. and D. Galai. (1983). “Information Effects on the Bid-Ask Spread.” The Journal of Finance 38, 1457–1469.
Demsetz, H. (1968). “The Cost of Transacting.” Quarterly Journal of Economics 83, 33–53.
Diamond, M. (1985). “Optimal Release of Information by Firms.” Journal of Finance 40, 1071–1094.
Diamond, D. and R. Verrecchia. (1991). “Disclosure, Liquidity and the Cost of Capital.” The Journal of Finance 46, 1325–1360.
Dreze, J. (1983). “Nonspecialist Teaching of Econometrics: A Personal Comment and Personalistic Lament.” Econometric Reviews 2, 291–299.
Easley, D. and M. O'Hara. (2004). “Information and the Cost of Capital.” The Journal of Finance, forthcoming.
Easley, D., S. Hvidkjaer and M. O'Hara. (2002). “Is Information Risk a Determinant of Asset Returns?” The Journal of Finance 57, 2185–2221.
Easton, P. (2004). “PE Ratios, PEG Ratios, and Estimating the Implied Expected Rate of Return on Equity Capital.” The Accounting Review, 79, 73–95.
Fox, J. (1997). Applied Regression Analysis, Linear Models, and Related. Thousand Oaks, CA: Sage Publications.
Frankel, R., M. McNichols and P. Wilson. (1995). “Discretionary Disclosure and External Financing.” The Accounting Review 70, 135–150.
Glosten, L. and P. Milgrom. (1985). “Bid Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders.” Journal of Financial Economics 14, 71–100.
Gode, D. and P. Mohanram. (2003). “Inferring Cost of Capital Using the Ohlson-Juettner Model.” Review of Accounting Studies 8, 339–431.
Greenstein, M. and H. Sami. (1994). “The Impact of the SEC's Segment Disclosure Requirement on Bid-Ask Spreads.” The Accounting Review 69, 179–199.
Grossman, S. and J. Stiglitz. (1980). “On the Impossibility of Informationally Efficient Markets.” American Economic Review 70, 393–408.
Handa, P. and S. Linn. (1993). “Arbitrage Pricing with Estimation Risk.” Journal of Financial and QuantitativeAnalysis 28, 81–100.
Healy, P., A. Hutton and K. Palepu. (1999). “Stock Performance and Intermediation Changes Surrounding Sustained Increases in Disclosure.” Contemporary Accounting Research 16, 485–520.
Jones, C. and S. Slezak. (1999). “The Theoretical Implications of Asymmetric Information on the Dynamic and Cross-Sectional Characteristics of Asset Returns.” Working paper, University of North Carolina, Chapel Hill.
Kennedy, P. (1998). A Guide to Econometrics, Fourth Edition. Cambridge, MA: The MIT Press.
Kim, O. and R. Verrecchia. (1991). “Trading Volume and Price Reactions to Public Announcements.” Journal of Accounting Research 29, 302–321.
Kim, O. and R. Verrecchia. (1994). “Market Liquidity and Volume Around Earnings Announcements.” Journal of Accounting and Economics 17, 41–67.
King, R., G. Pownall and G. Waymire. (1990). “Expectations Adjustment Via Timely Management Forecasts: Review, Synthesis, and Suggestions for Future Research.” Journal of Accounting Literature 9, 113–144.
Klein, R. and V. Bawa. (1976). “The Effect of Estimation Risk on Optimal Portfolio Choice.” Journal of Financial Economics 5, 215–231.
Lang, M. and R. Lundholm. (2000). “Voluntary Disclosure and Equity Offerings: Reducing Information Asymmetry or Hyping the Stock?” Contemporary Accounting Research 17, 623–662.
Lee, C., B. Bucklow and M. Ready. (1994). “Spreads, Depths and the Impact of Earnings Information: An Intraday Analysis.” The Review of Financial Studies 6, 345–374.
Leuz, C. and R. Verrecchia. (2000). “The Economic Consequences of Increased Disclosure.” The Journal of Accounting Research 38, 91–124.
Litner, J. (1965). “The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” The Review of Economics and Statistics 47, 13–37.
Lundholm, R. (1988). “Price-Signal Relations in the Presence of Correlated Public and Private Information.” Journal of Accounting Research 36, 107–118.
Lundholm, R. (1991). “Public Signals and Equilibrium Allocation of Private Information.” Journal of Accounting Research 29, 322–349.
Marquardt, C. and C. Wiedman. (1998). “Voluntary Disclosure, Information Asymmetry, and Insider Selling Through Secondary Equity Offerings.” Contemporary Accounting Research 15, 505–537.
McNichols, M. and B. Trueman. (1994). “Public Disclosure, Private Information Collection and Short-Term Trading.” Journal of Accounting and Economics 17, 69–94.
Mossin, J. (1966). “Equilibrium in a Capital Asset Market.” Econometrica 34, 768–783.
Ohlson, J. A. and B. Juettner-Nauroth. (2003). “Expected EPS and EPS Growth as Determinants of Value.” Working paper, New York University.
Raman, K. and N. Tripathy. (1993). “The Effect of Supplemental Reserve-Based Accounting Data on the Market Microstructure.” Journal of Accounting and Public Policy 12, 113–133.
Sharpe, W. (1964). “Capital Asset Price: A Theory of Market Equilibrium Under Conditions of Risk.” Journal of Finance 19, 425–442.
Venkataraman, R. (2000). “The Impact of SFAS 131 on Financial Analysts' Information Environment.” Working paper, Pennsylvania State University.
Verrecchia, R. (1982). “Information in a Noisy Rational Expectations Economy.” Econometrica 50, 1415–1430.
Verrecchia, R. (2001). “Essays on Disclosure.” Journal of Accounting and Economics 32, 97–180.
Wang J. (1993). “A Model of Intertemporal Asset Prices Under Asymmetric Information.” Review of Economic Studies, 249–282.
Welker, M. (1995). “Disclosure Policy, Information Asymmetry and Liquidity in Equity Markets.” Contemporary Accounting Research 12, 801–827.
About this article
Cite this article
Botosan, C.A., Plumlee, M.A. & Xie, Y. The Role of Information Precision in Determining the Cost of Equity Capital. Review of Accounting Studies 9, 233–259 (2004). https://doi.org/10.1023/B:RAST.0000028188.71604.0a
- private information
- cost of capital
- public information