[This paper presents a partially revealing rational expectations model of competitive trading to identify two effects of information releases; an informedness effect and a consensus effect. The informedness effect measures the extent to which agents become more knowledgeable, and the consensus effect measures the extent of agreement among agents at the time of an information release. We demonstrate that informedness and consensus generally occur jointly when information is disseminated, and that unexpected price changes and trading volume are each influenced by both informedness and consensus. Thus, interpretations of unexpected price changes and volume associated with information releases are conceptually similar. Since informedness and consensus each affect both the variance of price changes and volume, our paper provides an economic rationale for examining both price and volume effects at the time of information releases.]

We identify a pecuniary externality arising from corporate tax avoidance. Firms share risk with the government via taxation. The lower the tax rate applied to a firm’s earnings, the more risk its shareholders bear. As more firms avoid taxes, the variance of the market’s after-tax cash flow increases. Consequently, the covariance of a firm’s cash flow with the market cash flow and thereby its cost of capital increases. This occurs regardless of a firm’s tax avoidance. Consistent with our prediction, we find that firms’ implied cost of capital relates positively to aggregate corporate tax avoidance regardless of a firm’s level of tax avoidance. As we predict, the pecuniary externality is stronger for firms whose cash flow covaries more with the market cash flow and is driven by tax avoidance strategies that reduce a firm’s marginal tax rate (e.g., income shifting of U.S. multinationals) as opposed to reducing its tax base.

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.

This paper examines a process by which information-revealing prices are determined by considering the private incentives of a price-setting agent (whom we refer to as a specialist). The specialist has private information that may be (partially) revealed through his choice of a pricing rule. We define an equilibrium as a pricing rule and a response to that rule by a representative trader that maximizes the expected utilities of the specialist and the trader, conditional on each having rational expectations. By analyzing the existence and nature of this equilibrium, we attempt to develop further insights into the behavior of markets with incomplete information.

Christian Leuz, Robert E. Verrecchia, The Economic Consequences of Increased Disclosure, Journal of Accounting Research, Vol. 38, Supplement: Studies on Accounting Information and the Economics of the Firm (2000), pp. 91-124

Louis J. Billera, David C. Heath, Robert E. Verrecchia, A Unique Procedure for Allocating Common Costs from a Production Process, Journal of Accounting Research, Vol. 19, No. 1 (Spring, 1981), pp. 185-196

We extend a standard, rational expectation model of trade to incorporate the possibility of individual investors delegating their trades to an informed financial intermediary. In the presence of delegated trade, we show that a firm׳s risk premium is a function of both the firm׳s exposure to a common risk factor and idiosyncratic characteristics of the firm׳s information environment. We show that even in a large economy, priced risks can manifest in the form of both idiosyncratic firm characteristics and common risk factors; as a consequence, factor-based asset pricing tests cannot rule out that a particular risk is priced.

This paper examines the relation between information differences across investors (i.e., information asymmetry) and the cost of capital and establishes that with perfect competition information asymmetry makes no difference. Instead, a firm’s cost of capital is governed solely by the average precision of investors’ information. With imperfect competition, however, information asymmetry affects the cost of capital even after controlling for investors’ average precision. In other words, the capital market’s degree of competition plays a critical role for the relation between information asymmetry and the cost of capital. This point is important to empirical research in finance and accounting.