Academic journal article Review of Business

The Relationship of Asymmetric Information, Financing Decisions and Cost of Capital in Brazilian Public Companies

Academic journal article Review of Business

The Relationship of Asymmetric Information, Financing Decisions and Cost of Capital in Brazilian Public Companies

Article excerpt

Executive Summary

Purpose: The purpose of this work is to analyze the influence of asymmetric information on the financing decisions and cost of equity capital of listed Brazilian companies between 2004 and 2007.

Design/methodology/approach: We construct two panel-data models, based on the model of Ohlson and Juettner-Nauroth (2005), using the debt level and cost of equity capital as the dependent variables. The variable explaining asymmetric information is based on analysts' errors in forecasting earnings per share.

Findings: The results indicate that the control variables Tangibility, Profitability and Risk are important determinants of the capital structure of the firms analyzed, and the Size variable is the most significant to explain variations in their cost of capital. However, in both models the variable representing information asymmetry is not statistically significant, leading to rejection of the research hypotheses. Nevertheless, even faced with these results, it is not possible to affirm that information asymmetry has no influence on the financing decisions and cost of capital of Brazilian firms, only that asymmetry, when represented by the percentage of analysts' errors in forecasting earnings per share, is not statistically significant to explain the variations in the indebtedness levels and cost of equity capital of the Brazilian companies analyzed in this study. This indicates the importance of the proxies utilized to represent the information asymmetry attribute. This result can also indicate a need to analyze the quality of analysts' predictions regarding Brazilian companies.

Research limitations/implications: This work has only analyzed Brazilian public companies. Also, for future works, we suggest the use of other proxies representative of the information asymmetry and the analyses of the quality of analysts' predictions regarding Brazilian companies.

Practical implications: Better knowledge of how information asymmetry affects the cost of capital will contribute to ratify the role of accounting in reducing this asymmetry in the capital market, since trustworthy accounting disclosure can reduce firms' cost of capital.

Originality/value: Because most studies in the literature on capital structure focus on developed economies, it is first important to analyze how well the existing theories fit the reality of different countries, mainly developing ones. Also, in this work we use the percentage error of analysts' forecasts of earnings per share (EPS) as a proxy for information asymmetry. We believe that using this variable to measure this asymmetry in the Brazilian capital market is one of the most important contributions of this paper, by adding to knowledge on the theme and innovating on the methods used to date, to enable obtaining more statistically robust results.

1. Introduction

The pecking order theory (Myers and Majluf, 1984 and Myers, 1984) focuses on asymmetric information as an important determinant of firms' financing decisions. According to this theory, firms should prefer internal over external financing for new investments, and if external financing is necessary, they should prefer issuing debt rather than equity securities, because of the information transmitted to the market by each type of security, with the type less sensitive to information preferable.

Some recent studies in the international literature relating information asymmetry with capital structure have found evidence that this asymmetry plays a strong quantitative role in determining firms' capital structure (Halov and Heider, 2003; Halov and Heider, 2005; Berger et al., 2005; Agarwal and O'Hara, 2007; Bharath, Pasquariello and Wu, 2009).

Various studies also indicate there is a relation between information asymmetry and cost of equity capital. Easley and O'Hara (2004) developed an asset pricing model in which the return on assets depends on public and private information. …

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