Disclosure, Liquidity, and the Cost of Capital

  • Author(s): DOUGLAS W. DIAMOND, ROBERT E. VERRECCHIA
  • Published: Apr 30, 2012
  • Pages: 1325-1359
  • DOI: 10.1111/j.1540-6261.1991.tb04620.x

ABSTRACT

This paper shows that revealing public information to reduce information asymmetry can reduce a firm's cost of capital by attracting increased demand from large investors due to increased liquidity of its securities. Large firms will disclose more information since they benefit most. Disclosure also reduces the risk bearing capacity available through market makers. If initial information asymmetry is large, reducing it will increase the current price of the security. However, the maximum current price occurs with some asymmetry of information: further reduction of information asymmetry accentuates the undesirable effects of exit from market making.

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