information asymmetry

Examples of information asymmetry in the following topics:

• Role of Financial Markets in Providing Feedback to Management

  • Management often has imperfect information about its own business, especially its business' value in the outside world .
  • For example, investors who hold shares in multiple firms in a sector may have more information about the prospects in that sector than the manager of one firm in that sector.
  • In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one party has more or better information than the other, creating an imbalance of power.
  • Financial economists have applied information asymmetry in studies of differentially informed financial market participants (insiders, stock analysts, investors, among others).

• Signaling

  • Signaling took root in the idea of asymmetric information, which says that in some economic transactions, inequalities in access to information upset the normal market for the exchange of goods and services .
  • An information asymmetry exists if firm managers know more about the firm and its future prospects than the investors.
  • When investors have incomplete information about the firm (perhaps due to opaque accounting practices) they will look for other information in actions like the firm's dividend policy.
  • Miller and Rock pointed out that this is likely due to the information content of dividends.
  • Describe what information a shareholder can obtain from a company issuing dividends

• Pecking Order

  • In corporate finance pecking ordering consideration takes into account the increase in the cost of financing with asymmetric information.
  • Pecking order theory basically states that the cost of financing increases with asymmetric information.
  • Goyal and Frank show, among other things, that Pecking Order theory fails where it should hold, namely for small firms where information asymmetry is presumably an important problem.

• Investor Preferences

  • There are a number of factors, such as psychology, taxes, and information asymmetries tied into this puzzle, which further complicate the matter.

• The Nature of Dividends

  • Due to information asymmetry between investors and the firm managers, investors will look to indicators like dividend decisions.
  • Managers have more information than investors about the firm, and such information may inform their dividend decisions.
  • Conversely, managers that have access to information that indicates very good future prospects for the firm are more likely to increase dividends.

• Optimal Capital Structure Considerations

  • Actual market considerations when dealing with capital structure include bankruptcy costs, agency costs, taxes, and information asymmetry.

• Time Lags and Targets

  • First, the Federal Reserve or government needs data and information before it can do anything, the information lag.
  • First, the Fed must easily measure the intermediate target in order to overcome information lags.
  • Japanese and U.S. struggling economies lead to the idea of cyclical asymmetry, which is the contractionary monetary policy is always effective, while expansionary monetary can be impotent at times.

• Information Costs and Bond Prices

  • If investors need time and money to acquire information on securities, then they pay a greater information cost.
  • We can use the demand and supply analysis to create two markets for the high and low information- cost bond markets.
  • Investors pay a greater cost to acquire information for the high information cost bonds.
  • Thus, investors are attracted to the low-information cost bonds, boosting their demand for low information cost bonds, increasing the market price and decreasing market interest rate.
  • Therefore, low-information-cost bonds pay a lower interest rate.

• Signaling Consideration

  • Signaling is the conveyance of nonpublic information through public action, and is often used as a technique in capital structure decisions.
  • In economics and finance, signaling is the idea that a party may indirectly convey information about itself, which may not be public, through actions to other parties.
  • Signaling becomes important in a state of asymmetric information (a deviation from perfect information), which says that in some economic transactions inequalities in access to information upset the normal market for the exchange of goods and services.
  • In his seminal 1973 article, Michael Spence proposed that two parties could get around the problem of asymmetric information by having one party send a signal that would reveal some piece of relevant information to the other party.
  • In terms of capital structure, management should, and typically does, have more information than an investor, which implies asymmetric information.

• The Efficient Market Hypothesis

  • The semi-strong-form EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information.
  • The strong-form EMH additionally claims that prices instantly reflect even hidden or "insider" information.
  • This implies that future price movements are determined entirely by information not contained in the price series.
  • In semi-strong-form efficiency, it is implied that share prices adjust to publicly available new information very rapidly and in an unbiased fashion, such that no excess returns can be earned by trading on that information.
  • In strong-form efficiency, share prices reflect all information, public and private, and no one can earn excess returns.