Information Asymmetry and Investment-Cash Flow Sensitivity

Bryant University, Department of Finance, United States
Journal of Banking & Finance (Impact Factor: 1.29). 06/2008; 32(6):1036-1048. DOI: 10.1016/j.jbankfin.2007.09.018
Source: RePEc


Models of capital market imperfections predict that information asymmetry decreases firm investment and increases the sensitivity of investment expenditures to fluctuations in internal funds. Previous empirical tests of the link between investment and financing decisions have relied on indirect measures of financial constraint due to market frictions. In contrast, we use more direct measures derived from the market microstructure literature. Consistent with the theoretical predictions, our analysis shows that scaled investment expenditures are on average lower and the investment–cash flow sensitivity is greater when the probability of informed trading is high. Our results are robust to alternative measures of informed trading and liquidity, but they are not pervasive in our sample.

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Available from: John B. Mcdermott, Dec 17, 2014
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    • "In addition, we further investigate the alternative explanation that the pricing impact of VECIN is simply a result of mispricing. Hirshleifer and Jiang (2010) use equity and debt financing to identify common mispricing across firms and construct a mispricing announcement drift (Vega (2006)), and firm investment and its sensitivity to cash flow (Chen, Goldstein and Jiang (2007) and Ascioglu, Hegde and McDermott (2008)), to list just a few examples. "
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    ABSTRACT: The price discovery function measures the private information revealed in prices through trades. As informed traders prefer large trades, the price discovery function of large trades (VECIN), estimated from a vector error correction model of cointegrated price series of large and small trades, measures the extent of information asymmetry between traders. VECIN has a strong impact on future stock returns, and its power to predict stock returns is stronger than any of the well-known return predictors we have considered. A VECIN spread portfolio of NYSE/Amex stocks that goes long in the top VECIN quintile and short in the bottom VECIN quintile earns a Fama-French (1993) risk-adjusted return of 0.99% per month. Adding the VECIN spread portfolio to the Fama-French three factors triples the Sharpe ratio of the ex-post tangency portfolio from 0.24 to 0.71. Further tests suggest that mispricing cannot fully explain the strong pricing impact of VECIN.
    SSRN Electronic Journal 09/2011; DOI:10.2139/ssrn.1688229
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    • "Given that board independence is a determinant of board effectiveness ( John & Senbet, 1998), Anglo-Saxon boards may appear more efficient, with their higher proportion of nonexecutive (or independent) directors. Furthermore , from an agency perspective, independent boards are mechanisms that reduce informational opacity, which will likely lead to lower R&D investment-cash flow sensitivity (Ascioglu et al., 2008), and are better at interfacing with the external environment (Pfeffer & Salancik, 1978). "
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    ABSTRACT: We investigate the process through which country-level corporate governance facilitates firm-level investment in research and development (R&D). Taking cash flow as one of the main determinants of R&D, we derive an econometric model that introduces a number of corporate governance factors (legal protection, financial system, and control mechanisms) to analyze their impact on R&D-cash flow sensitivity. Using data from nine European Union countries, Japan, and the United States, we show that R&D at the firm level is less sensitive to internal cash flow in countries with effective investor protection, developed financial systems, and strong corporate control mechanisms. Specifically, our analysis suggests that the characteristics of the corporate governance system that facilitate R&D are a common law legal environment, minority shareholder protection, strong law enforcement, a bank-based financial system, effective board control, and a strong market for corporate control. This evidence points to corporate governance as a key element in R&D investment, and contributes to the debate on whether country-level corporate governance systems can facilitate R&D projects and, indirectly, promote economic growth.
    Journal of International Business Studies 01/2011; 42(1):76-98. DOI:10.1057/jibs.2010.46 · 3.56 Impact Factor
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    • "For example, our measure can be used to study the impact on the cost of capital of events that are hypothesized to affect information production such as the implementation of Regulation Fair Disclosure (Duarte, Han, Harford and Young (2008)). This more powerful information risk measure can also be used to study or re-examine the interactions between information asymmetry and 1) corporate governance (Ferreira and Laux (2007)); 2) regular conference calls (Brown, Hillegeist and Lo (2004)); 3) earnings report outcomes (Jayaraman (2008)); 4) conservatism in financial statements (LaFond and Watts (2008)); 5) post-earnings announcement drift (Vega (2006)); and 6) firm investment and its sensitivity to cash flows (Chen, Goldstein and Jiang (2007) and Ascioglu, Hegde and McDermott (2008)). "
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    ABSTRACT: We develop an information risk measure (ECIN) based on the price discovery of large trades. As the price series of large trades and small trades are cointegrated, the price discovery of trades can be easily estimated via the vector error-correction model (VECM). Intuitively, we use the VECM to study how a temporary gap between the large trade price and the small trade price for the same stock is closed. If most of the gap is closed through adjustment in the small trade price with little movement in the large trade price, this indicates large trade price has been closer to the long-run equilibrium price and hence that the large trade price has a greater price discovery function for the stock in question. Since informed traders prefer to trade in large size, firms whose large trades have a larger price discovery are deemed to have larger information risk. An important feature of ECIN that is inherent to its construction is that higher ECIN also means lower illiquidity. This feature helps to disentangle the pricing impact of information risk from that of illiquidity - a major advantage over other information risk measures in the asset pricing tests of information risk. We show that ECIN is priced and its predictive power of stock returns is far more significant than those of book-to-market and momentum.
    SSRN Electronic Journal 10/2010; DOI:10.2139/ssrn.1572088
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