FOREIGN TRADE UNIVERSITY

FACULTY OF BANKING AND FINANCE

GRADUATION THESIS
Major: Banking and International Finance

THE IMPACTS OF INFORMATION ASYMMETRY ON

COST OF EQUITY CAPITAL OF LISTED COMPANIES
IN THE VIETNAMESE STOCK MARKET

Student’s Full Name: Nguyen Tuyet Nhung

Student ID: 1001030268
Intake: 49 – A4 – CLC
Supervisor: Assoc. Prof. Nguyen Viet Dzung, PhD.

Hanoi, May 2014

 ACKNOWLEDGEMENT
First and foremost, I would like to express my deepest appreciation to my
supervisor, Assoc. Prof. Nguyen Viet Dzung (PhD.), Lecturer of Foreign Trade
University for his guidance, encouragement and support throughout my research
period. His suggestion and advices were really a great source of spirit to make my
thesis improved significantly.
Furthermore, I would like to express my gratitude to all lecturers of Faculty
of Banking and Finance of Foreign Trade University for their useful and valuable
lectures on concerning fields.
Lastly, I am heartily thankful to my beloved family and friends. Their
encouragement and support have provided me with strength and inspiration for
completion of this thesis.
Nguyen Tuyet Nhung
 TABLE OF CONTENT
CHAPTER 1: INTRODUCTION ........................................................................1

1.1. Rationale of the study .....................................................................................1

1.2. Objectives of the study ...................................................................................3
1.3. Scope and subjects of the study .....................................................................3
1.4. Methodology ....................................................................................................3
1.5. Structure of the study .....................................................................................4

CHAPTER 2: THEORETICAL BACKGROUND AND

LITERATURE REVIEW .........................................................................................5

2.1. Theoretical background .................................................................................5

2.1.1. Overview of information asymmetry......................................................5
2.1.2. Overview of the cost of equity capital...................................................15
2.1.3. Theoretical bases of the impacts of information asymmetry on cost of
equity capital .....................................................................................................21
2.2. Prior researches examining the link between asymmetric information
and cost of equity capital .....................................................................................23
2.2.1. Supporters of the positive association between asymmetric
information and cost of equity capital ............................................................23
2.2.2. Critics of the positive association between asymmetric information
and cost of equity capital .................................................................................26

CHAPTER 3: RESEARCH METHODOLOGY .............................................30

3.1. Research design .............................................................................................30

3.2. Measurements of variables ..........................................................................31
3.2.1. Dependant variable - cost of equity capital ..........................................31
3.2.2. Independent variables- Information asymmetry proxies ...................34
3.2.3. The control variables..............................................................................38
3.3. Sample selection and data collection ...........................................................39
3.3.1. Sample selection ......................................................................................39
3.3.2. Data collection.........................................................................................40
3.4. Expected results ............................................................................................43
CHAPTER 4: EMPIRICAL RESULTS AND DISCUSSION ........................44

4.1. Data statistical description ...........................................................................44

4.2. Regression results .........................................................................................46
4.2.1. Regression of implied cost of equity on control variables and adverse
selection cost ......................................................................................................46
4.2.2. Regression of implied cost of equity on control variables and
earnings management measures .....................................................................47
4.2.3. Regression of implied cost of equity on control variables and residual
volatility .............................................................................................................49
4.2.4. Summary .................................................................................................50
4.3. Assumption tests ...........................................................................................50
4.3.1. Multicollinearity test ..............................................................................51
4.3.2. Heteroscedasticity test ............................................................................52

CHAPTER 5: CONCLUSION AND RECOMMENDATIONS .....................54

5.1. Conclusion .....................................................................................................54

5.2. Recommendations .........................................................................................57
5.2.1. Recommendations to investors ..............................................................57
5.2.2. Recommendations to listed companies .................................................58
5.2.3. Recommendations to securities companies ..........................................59
5.2.4. Recommendations to financial regulatory authorities ........................59
5.3. Limitations of the study................................................................................61
5.4. Suggestions for future study ........................................................................62

REFERENCES ........................................................................................................64

APPENDIX 1 ...........................................................................................................68

APPENDIX 2 ...........................................................................................................70
 LIST OF ABBREVIATION

Abbreviation Meaning
CAPM Capital Asset Pricing Model
DPS Dividend per share
DPR Dong Phu Rubber company
EPS Earnings per share
HOSE Ho Chi Minh Stock Exchange
HNX Hanoi Stock Exchange
NYSE New York Stock Exchange
OLS Ordinary Least Squares
PEG Price-earnings growth
RIM Residual Income Model
ROE Return on Equity
VIF Variance Inflation Factors
 LIST OF TABLES

Table 3-1 Summary of data sources ..........................................................................41

Table 3-2 Summary of data measurement process ...................................................42
Table 4-1 Data statistical description ........................................................................44
Table 4-2 Regression result of Model 1 ....................................................................46
Table 4-3 Regression result of Model 2 ....................................................................48
Table 4-4 Regression result of Model 3 ....................................................................49
Table 4-5 Correlation matrix of variables .................................................................51
Table 4-6 VIF of three models ..................................................................................52
Table 4-7 White’s test results of three models ..........................................................53
Table A-1: Estimating the expected growth rate of DPR .........................................68
Table A-2: Regression result of Glosten and Hariss model for DPR .......................70
Table A-3: Adverse selection cost of 222 listed companies in the sample ...............71
 1

CHAPTER 1: INTRODUCTION
1.1. Rationale of the study
On July 10th 1998, the Prime Minister signed Decree No. 48/1998/ND-CP to
establish two securities trading centers at Hanoi and Ho Chi Minh City, or officially
set up Vietnamese stock market with the aim of restructuring the economy,
developing and enhancing the financial market by facilitating the process of
mobilizing capital through debt securities and capital securities. After more than 15
years of putting into operation, Vietnamese stock market has obtained significant
achievements in the process of fulfilling their role of mobilizing capital and creating
more investment opportunities for individuals and organizations within or outside
the country. Nevertheless, there are still some drawbacks or limitations which
inhibit the sustainable development of the stock market such as the ineffective and
unsystematic of regulatory systems, the strong possibility of high risk, the lack of
capacity and knowledge in investors… and one of the most serious issues is
information asymmetry or poor information disclosure system. Originating from the
study of George Akerlof in 1970 paper named "The Market for Lemons: Quality
Uncertainty and the Market Mechanism", the information asymmetry theory has
gained a longstanding concerns from both researchers and regulators throughout the
world because of its serious consequences on financial market which are adverse
selection and moral hazard. As for the newly-established and developing stock
market like Vietnam, information asymmetry can trigger numerous problems such
as leading to the inaccurate investment decisions of investors, reducing liquidity,
causing virtual supply and demand, bubble market, and even posing a threat of
market failure. According to statistics, in 2013, only 29 out of the 694 listed
companies on both national stock exchanges took the initiative to distribute
compulsory information to investors, as required by Circular 52/2012/TT-BTC of
the State Securities Commission about publishing information on the stock
exchanges. The remaining 95 percent of listed companies were found to have not
released information, which can pose a serious threat to the stable growth of
Vietnamese stock market. As a result, it is crucial for researcher and economists to
 2

conduct thorough studies on the effects of information risk on stock market in

Vietnam.
Regarding to another important and fundamental issues in accounting, finance
and economics, it is evident that the cost of equity capital plays a vital role in
influencing the operations of the firm and its subsequent profitability, from
determining the hurdle rate for investment projects to influencing the composition
of the firm’s capital structure. The cost of capital is also used by regulators in
making decisions on the rates charged by the firms operating in regulated industries
like utilities. Likewise, for investors, cost of capital is a proxy of the return they
receive on their investment that affects their welfare. On the macro level, lower cost
of capital triggers greater investment, which is good for the economy as a whole. As
a matter of fact, in Vietnam, one of the toughest challenges facing a number of
enterprises is the high cost of capital and the ineffective allocation of capital. This
emerging issue also fueled a lot of worries and concerns from Vietnamese
economists and participants of capital market.
Taking into account both of two important and urgent issues, there are a large
number of theoretical and empirical researches examining the link between
information and cost of equity capital throughout the world for many years. The
prevalence of this topic research can be supported by the fact that a better
understanding of the relationship between information and cost of capital, the
incentives involved and consequences of asymmetry seems important from the
point of view of both the growing body of accounting theory and a more effective
design of regulation policies from agencies. However, while several theoretical and
empirical researches suggest that increased information asymmetry can raise cost of
equity capital, some studies cannot reach the consensus and give the contradictory
conclusions. Moreover, in Vietnam, there is a lack of sufficient empirical evidences
and studies investigating such a crucial association. Therefore, it is undoubtedly
important for the researcher to conduct the research “The impacts of information
asymmetry on cost of equity capital of listed companies in the Vietnamese stock
market” to make an contribution to the development of this research body as well
as to the stable growth of financial market in Vietnam in general.
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1.2. Objectives of the study

The main purpose of this research is to examine the cross-sectional relation
between information asymmetry and cost of equity capital in the Vietnamese stock
market. To be more specific, after measuring the degree of information asymmetry
and cost of equity capital by some proxies, this study will answer the question of
whether or not there are any relationship between information asymmetry and cost
of equity, whether this association is negative or positive and the reasons for this
finding. By exploring the answers for these questions, this research can make
significant implications for managers, investors, regulatory authorities in their
investment or management decisions and policies with the long –term purpose of
enhancing the efficiency and transparency of financial market, especially for
emerging and developing stock market like Vietnam.

1.3. Scope and subjects of the study

This research will focus on companies listed on the Ho Chi Minh Stock
Exchange (HOSE) to investigate the association between information asymmetry
and cost of equity of these companies during the one-year period from 1/1/2013 to
31/12/2013. These listed companies comes from various industries, except for
financial services sector in order to give the most sufficient and unbiased results.
Besides, this research only concentrate on the cost of equity capital, not other
components of cost of capital like cost of debt or preferred stocks because cost of
equity is the component that receive most of attention in the literature (Botosan,
2006) and has a large impact on investment and management decision of managers.
The main subjects of this research are the level of information asymmetry, the
estimated cost of equity and the cross-sectional relation between them.

1.4. Methodology
This research will apply the quantitative research approach by using regression
models like OLS or solving the quadratic equations to measuring unobservable
subject like information asymmetry and estimating the cost of equity. Furthermore,
to investigate the association between information asymmetry and cost of equity,
the researcher continues to employ the regression model as well as statistical
 4

description and testing OLS assumptions techniques to detect violation as well as

examine the appropriateness of the model and reach the conclusion.

1.5. Structure of the study

The remainder of this research will be structured as follows:
- Chapter 2: Theoretical background and literature review will present in
details the theoretical background of information asymmetry and cost of equity
capital from the definition, classification to several methods to measure both of
them. More importantly, in this past, the researcher will summarize prior researches
relating to the cross-sectional relation between information asymmetry and cost of
equity capital from both theoretical and empirical perspectives.
- Chapter 3: Research methodology will indicate the research design, the
process of measuring and collecting data as well as selecting sample.
- Chapter 4: Empirical results and discussion will present the data statistical
description as well as the regression results and some OLS assumption test for the
model.
- Chapter 5: Conclusion and recommendations will draw a conclusion of the
thesis, analyze the reasons for these findings, give some recommendations for all
parties related, and indicate some limitations as well as suggestions for future
studies.
 5

CHAPTER 2: THEORETICAL BACKGROUND AND

LITERATURE REVIEW
2.1. Theoretical background
2.1.1. Overview of information asymmetry
2.1.1.1 Definitions of information asymmetry
- Basically, information asymmetry is a situation in which one party in a
transaction has more or superior information compared to another. Potentially, this
could be a harmful situation because one party can take advantage of the other
party's lack of knowledge.
- N.Mankiw (2002) defined that a different access to knowledge that is
relevant to an interaction is called an information asymmetry. For example, a
worker knows more than his employer about how much effort he puts into his job or
a seller of a used car knows more than the buyer about the car’s condition. In each
case, the uninformed party (the employer, the car buyer) would like to know the
relevant information, but the informed party (the worker, the car seller) may have an
incentive to conceal it.
Regarding to the origin of the concept “information asymmetry”, it was first
introduced by George Akerlof in his 1970 paper named "The Market for Lemons:
Quality Uncertainty and the Market Mechanism", which examined the markets
where the seller know more information relating to the quality of products than the
buyer. A typical example is the used car market where Akerlof used “lemon” as an
American slang term for a car that is found to be defective only after it has been
bought. Akerlof argues that this information asymmetry gives the seller an incentive
to sell goods of less than the average market quality. In other words, the owners of
the worst cars are more likely to sell them than are the owners of the best cars.
Buyers also acknowledging the existence of the information symmetry thus try to
avoid them by choosing to buy goods with an average price. As a result, the owners
of good quality merchandises knowing that the value of their cars is higher than
average level cannot accept the average price, and then withdraw from the market.
 6

Consequently, the "bad" cars tend to drive out the good or gradually, in the used car
market there are only poor quality cars or “lemons”.
Over many years, the theory of asymmetric information has confirmed the
crucial role in the economy, especially in 2011 when the Nobel Prize in Economics
was awarded to George Akerlof, Michael Spence, and Joseph E. Stiglitz for their
"analysis of markets with asymmetric information". It is a sign of how important the
economics of information has become, and encourage economists to devote much
effort in recent decades to studying the roles of information in financial market.

2.1.1.2 Types of asymmetric information

Based on the distinct consequences of asymmetric information, it can be
classified into two types as follows:

 Adverse selection
Adverse selection is often referred as a hidden characteristic problem or the
problem created by asymmetric information before the transaction occurs that
emerges in markets where the seller knows more about the attributes of the good
being sold than the buyer does. As a result, the buyer runs the risk of being sold a
low quality good. That is, the “selection” of goods being sold may be “adverse”
from the standpoint of the uninformed buyer (Mankiw, 2002; Estrin and Laidler,
1995).
In the financial market, adverse selection is a situation where the managers
as well as those insiders will know more about the conditions and the prospects
of the company than outside investors and can exploit their information
advantage at the expense of outsiders, for example, by biasing or otherwise
managing the information released to investors. This may affect the ability of
investors to make good investment decisions (Scott, 2003). Another example of
adverse selection occurring when the potential borrowers who are the most likely to
produce an undesirable (adverse) outcome – the bad credit risks – are the ones who
most actively seek out a loan and are thus most likely to be selected. In this context,
the lenders will suffer adverse selection because they are not capable of
distinguishing between projects with different credit risks and being exploited by
 7

the borrowers undertaking risky activities and hiding the true nature of the project
(Bebczuk, 2003).

 Moral hazard
Moral hazard is sometimes referred as a hidden action problem that arises
when one side of the market cannot observe the actions of the other one person. In
other words, there are two parties: one called the agent who is performing some task
on behalf of another person, called the principal. If the principal cannot perfectly
monitor the agent’s behavior, the agent tends to undertake less effort than the
principal considers desirable. The phrase moral hazard refers to the risk, or
“hazard”, of inappropriate or otherwise “immoral” behavior by the agent. In such a
situation, the principal has to apply various ways to encourage the agent to act more
responsibly (Varian, 1990; Mankiw, 2002).
In the financial market, moral hazard problem can occur because of
separation of ownership and control in most large business entities. It is inevitable
that activities conducted by a manager are not entirely noticed or observed directly
by shareholders and lenders. Therefore, the manager could perform actions outside
the knowledge of shareholders or be tempted to blame any deterioration of firm
performance on factors beyond their control. As a consequence of this tendency,
there are serious implications both for investors and for efficient operation of the
economy (Scott, 2003). In another situation, moral hazard can appear when the
borrowers tend to apply the funds to different uses than those agreed upon with the
lender, who is inhibited by his lack of information and control over the borrower
(Bebczuk, 2003).

2.1.1.3 Measuring asymmetric information in the financial market

According to Clarke and Shastri (2000), due to the fact that the degree of
information asymmetry is not directly observable, researchers must rely on proxy
variables. These proxies can be divided into three broad categories: measures based
on analysts’ forecasts, investment opportunity set measures, and market
microstructure measures.
 8

 Analysts’ forecasts measures

Analysts are prominent information intermediaries in capital markets. They
engage in information search from public and private sources. Thus, the forecast
dispersion and error are considered to be straightforward, forward-looking and
comprehensive as measures of information asymmetry, and have been widely used
in the prior literature.
As the fiscal year ends, Elton, Gruber and Gultekin (1984) observed that
forecast errors decrease because information asymmetry is less and accuracy in
available information is higher. Blackwell and Dubins (1962) also demonstrate that
opinions tend to converge as the amount of information available about an unknown
quantity increases. In other word, all rational (and not too opinionated) agents will
agree given enough common data. Therefore, the analyst forecast reduces
information asymmetry in the market (Hughes and Ricks, 1987) and is adopted as a
proxy for measuring information asymmetry (Krishnaswami and Subramaniam,
1999; Gilson, Healy, Noe and Palepu, 2001; Li and Zhao, 2008). For example,
Krishnaswami and Subramaniam (1999) used the analyst forecast error to test for
change in the information environment before and after a spin-off transaction.
Besides, there are some problems often arising from this calculation that
forecast errors are typically biased. Prior evidence from archival studies suggests
that analysts’ earnings forecasts exhibit inefficiency, that is, they fail to accurately
incorporate new information on a timely basis. Fried and Givoly (1982), O’Brien
(1988), Francis and Philbrick (1993), Kang, O’Brien, and Sivaramakrishnan (1994),
and Dreman and Berry (1995) provide evidence that analysts’ forecasts are overly
optimistic. Other studies find that analyst forecasts underreact or overreact to public
information. Consequently, measures based on forecast errors may tend to misstate
the degree of information asymmetry. Another criticism of the use of forecast
errors as a measure of information asymmetry is that they might be correlated with
the riskiness of the firm. That is, some firms may have higher forecast errors
because they have more volatile earnings and not because of higher levels of
information asymmetry (Clarke and Shastri, 2000).
 9

 Investment opportunities set measures

The proxies in the investment opportunities group are the ratio of market
value to book value of equity, market to book value of the asset, the price
earnings ratio. Their use is based on the notion that the managers of companies
with high growth rates know better than the managers of firms with low growth
rates the investment opportunities and the future cash flows of their companies, a
fact which implies a lower degree of asymmetric information (Smith and Watts,
1992). Based on this reasoning, a number of studies have used proxies for a firm’s
investment opportunity set as measures of information asymmetry. For example,
McLaughlin, Safieddine and Vasudevan (1998) applied the ratio of firm’s market
value of equity to book value of equity to measure the relationship between
information asymmetry and the long-term performance of a company
following the public offer of ordinary shares. They found a direct correlation
between information asymmetry and negative abnormal performance following the
public offer of ordinary shares.
The main criticism for the use of these variables as proxies of asymmetric
information is that they have also been (Penman, 1996), valuation and market
mispricing, monopoly market power, whose influence cannot be readily separated
from the influence of asymmetric information (Antzoulatos et al., 2008).

 Microstructure measures
According to O’Hara (1995), market microstructure is concerned with the
process and outcomes of exchanging assets as guided by certain market rules and
regulations and in some effects the formation of asset prices. Gravelle (1999) argues
that a significant part of the researches on the microstructure of the securities
markets was devoted to equity market. The outcomes of the many studies done on
microstructure of equity markets include the development of several information
asymmetry models to cater for segments of the equity markets that possess insider
information about the stock expected value.
Generally, the market microstructure decompose the bid-ask spread into
three primary components: an order-processing component, an inventory
component, and an adverse selection component. The positive association between
 10

information asymmetry and the bid-ask spread is justified by the adverse selection
component of the spread that compensates the market makers or dealers for
transacting with better-informed traders from which they lose and increases with the
degree of information asymmetry.
Recently, numerous researchers have tried to measure the size of these costs
by developing models which decompose the bid-ask spread into components, one of
which is the adverse selection cost. According to Clarke and Shastri (2000), these
models can be divided into two groups as follows.
 Group 1
In one class of models introduced by Roll (1984), measurements of the bid-
ask spread is made from the serial covariance properties of the time series of
observed transaction prices. Models by Choi, Salandro, and Shastri (1988), George,
Kaul, and Nimalendran (1991) and Stoll (1989) fall into this category. Let us take a
closer look to one of the models belonging to this category, which is George, Kaul,
and Nimalendran (1991) model.
George, Kaul, and Nimalendran (1991) allow expected returns to be serially
dependent. The serial dependence has the same impact on both transaction returns
and quote midpoint returns. Hence, the difference between the two returns filters
out the serial dependence. The transaction return is:
𝑠𝑞 𝑠𝑞
𝑇𝑅𝑡 = 𝐸𝑡 + 𝜋 (𝑄𝑡 − 𝑄𝑡−1 ) + (1 − 𝜋) 𝑄𝑡 + 𝑈𝑡
2 2
Where:
𝐸𝑡 is the expected return from time t-1 to t;
𝜋 and (1 − 𝜋) are the fractions of the spread due to order processing and
adverse selection costs, respectively;
𝑠𝑞 is the percentage bid-ask spread (assumed to be constant through time);
𝑄𝑡 is a +1/-1 buy-sell indicator;
𝑈𝑡 represents public information innovations.
George et al. (1991) measure the quote midpoint immediately following the
transaction at time t. An upper case T subscript is used to preserve the timing
distinction for the quote midpoint. The midpoint return is:
 11

𝑠𝑞
𝑀𝑅𝑇 = 𝐸𝑇 + (1 − 𝜋) 𝑄 + 𝑈𝑇
2 𝑇
Subtracting the midpoint return from the transaction return and multiplying
by two yields:
2𝑅𝐷𝑡 = 𝜋𝑠𝑞 (𝑄𝑡 − 𝑄𝑡−1 ) + 𝑉𝑡
where 𝑉𝑡 = 2(𝐸𝑡 − 𝐸𝑇 ) + 2(𝑈𝑡 − 𝑈𝑇 ). Relaxing the assumption that 𝑠𝑞 is constant
and including an intercept yields:
2𝑅𝐷𝑡 = 𝜋0 + 𝜋1 𝑠𝑞 (𝑄𝑡 − 𝑄𝑡−1 ) + 𝑉𝑡
The Lee and Ready (1991) procedure is used to determine trade
classification. OLS is also used to estimate the order processing component, 𝜋0 , and
an adverse selection component, (1- 𝜋1 ), for each stock in the sample.
 Group 2
In another class of models, Glosten and Harris (1988), Lin, Sanger, and
Booth (1995), Huang and Stoll (1997) and Madhavan, Richardson, and Roomans
(1997) fall into this category. These trade indicator models are primarily driven by
whether incoming orders are purchases or sales and the response of the price to this
order arrival. This research will investigate in detail one of the models of this
category, which is Glosten and Harris (1988) model.
Glosten and Harris (1988) model presents one of the first trade indicator
regression models for spread decomposition. According to Ness et al. (2001), a
unique characteristic of Glosten and Harris (1988) model is that they decompose
bid-ask spread into two parts: the adverse selection component, Z0, and the
combined order processing and inventory holding component, C0 and express both
of them as linear functions of transaction volume. The model is illustrated as
follows:
𝑃𝑡 − 𝑃𝑡−1 = 𝑐0 (𝑄𝑡 − 𝑄𝑡−1 ) + 𝑐1 (𝑄𝑡 𝑉𝑡 − 𝑄𝑡−1 𝑉𝑡−1 ) + 𝑧0 𝑄𝑡 + 𝑧1 𝑄𝑡 𝑉𝑡 + 𝜀𝑡
Where:
Pt and Pt-1 is the observed transaction price at time t and t-1;
Vt and Vt-1 is the volume or the number of shares traded in the transaction at
time t and t-1;
 12

Qt is a trade indicator that is +1 if the transaction is buyer initiated and –1 if

the transaction is seller initiated;
c0, c1, z0, z1 are the coefficients of the model and 𝜀𝑡 is statistical error.
After using OLS regression to obtain estimates for c0, c1, z0, and z1 for each
stock in the sample, Glosten and Harris (1988) calculate the adverse selection
component is Z0 = 2(z0+ z1Vt) and the order processing/inventory holding
component is C0 = 2(c0 + c1Vt).
To estimate the adverse selection component as a proportion of the spread,
Glosten and Harris (1988) use the average transaction volume for stock i as follows:
2 (𝑧0 + 𝑧1 𝑉̅𝑡 )
𝐴𝑆𝐶 =
2(𝑧0 + 𝑧1 𝑉̅𝑡 ) + 2(𝑐0 + 𝑐1 𝑉̅𝑡 )
where ASC is adverse selection component of spread; and 𝑉̅𝑡 is the average
transaction volume for stock i.
 Summary
The problem with the use of the bid-ask proxy is that the models generate
very different estimates of the adverse selection component and sometimes make a
very difficult task to isolate the influence of the other two components of the bid-
ask spread, namely the order processing and inventory components. The order-
processing or transaction costs pertain to the commission costs, taxes, clearance and
settlement fees, while the inventory holding costs are the opportunity costs relating
to carry long/short positions in securities (Antzoulatos et al, 2008)..
Apart from three main groups of information asymmetry proxies, there are
also other proxies that can be used by many empiricists to estimate the degree of
information asymmetry. These proxies include earning management, abnormal
return and residual volatility that are discussed in detail as follows.

 Earnings management measures

Healy and Wahlen (1999) defined earnings management as “managers’
judgment in financial reporting and in structuring transactions to alter financial
reports to either mislead some stakeholders about the underlying economic
performance of the company or to influence contractual outcomes that depend on
reported accounting numbers”.
 13

Bhattacharya et al. (2007) investigate the association between earnings

quality and information asymmetry for a broad sample of NYSE firms over the
period 1998–2007 and document that poor earnings quality is significantly
associated with higher information asymmetry as manifested in the adverse
selection component of trading cost. The impact of earnings quality on information
asymmetry is affected by the firm’s information environment and is more
pronounced for firm’s operating in a relatively impoverished disclosure
environment. Bachtiar (2007) also supports that poor earnings quality increase
information asymmetry, at least during periods when earnings-related information is
anticipated by market participants. The result proposes that the level of earnings
management used by managers, which is reflected in discretionary accrual, will
result in higher information asymmetry as reflected in higher bid-ask spread.
Therefore, earnings management measures can be used to estimate the degree of
information asymmetry in many studies.
The most common techniques for measuring earnings management used by
many research is to isolate the ‘discretionary’ portion of the accruals component of
earnings because in earnings management, it is accruals that change as a result of
management’s accounting decisions that are of interest, which is discretionary
accruals. Discretionary accruals represent managerial interventions into financial
reporting process and have been measured by numerous models that will be
indicated as follows.
 Friedlan (1994) model
Friedlan (1994) assumes that the change in total accruals between two
periods is composed of two components: the change due to firm growth and the
change due to incremental discretion by managers. To control for the effect of
growth on total accruals, a model that assumes a constant proportionality between
total accruals and sales in successive periods is used. The amount of total accruals
that is attributable to discretion is the difference between total accruals in the test
period standardized by sales in the test period and total accruals in the bench-mark
period standardized by sales in the benchmark period. The model is illustrated as
follows:
 14

𝑇𝐴𝐶𝐶𝑡 𝑇𝐴𝐶𝐶0
𝐷𝐴𝐶𝐶𝑡 = −
𝑅𝐸𝑉𝑡 𝑅𝐸𝑉0
Where: DACCt is the discretionary accruals in the test period;
TACCt is the total accruals in the test period;
TACC0 is the total accruals in the benchmark period;
REVt is sales in the test period;
REV0 is sales in the benchmark period;
As in DeAngelo (1986), total accruals are assumed to be net income before
extraordinary items minus cash flow from operations.
 John (1991) model
Jones (1991) uses a regression-type model to estimate non-discretionary
accruals in a given year based on the change in economic conditions. Specifically
she expects that working capital accruals are related to the change in sales and that
depreciation is related to the level of gross property, plant, and equipment. The
model used to estimate non-discretionary accruals is as follows:
𝑇𝐴𝐶𝑡 1 ∆𝑆𝑡 𝑃𝑃𝐸𝑡
= 𝑁𝐷𝐴𝑡 = 𝛼 ( ) + 𝛽1 ( ) + 𝛽2 ( ) + 𝜀𝑡
𝐴𝑡−1 𝐴𝑡−1 𝐴𝑡−1 𝐴𝑡−1

Where: 𝑇𝐴𝐶𝑡 is total operating accruals in year t;

𝐴𝑡−1 is total asset at the beginning of year t;
𝑁𝐷𝐴𝑡 is total non –discretionary accruals in year t;
∆𝑆𝑡 is change in sales from year t-1 to year t;
𝑃𝑃𝐸𝑡 is gross plant, property and equipment.
The discretionary accrual component is estimated as the difference between
total accruals and the non-discretionary component using the coefficients from the
above regression.
 The modified John model (Dechow, Sloan, & Sweeney, 1995)
Dechow, Sloan, & Sweeney (1995) argue that all revenue changes in the Jones
models are non-discretionary, and the resulting measure of discretionary accruals
does not reflect the impact of sales based manipulation. As a result, Dechow attempt
to capture revenue manipulation and altered the Jones model by subtracting
 15

the change in receivables from changes in sales. The Modified Jones model
becomes:
𝑇𝐴𝐶𝑡 1 ∆𝑆𝑡 − ∆𝑅𝐸𝐶𝑡 𝑃𝑃𝐸𝑡
= 𝑁𝐷𝐴𝑡 = 𝛼 ( ) + 𝛽1 ( ) + 𝛽2 ( ) + 𝜀𝑡
𝐴𝑡−1 𝐴𝑡−1 𝐴𝑡−1 𝐴𝑡−1
 Abnormal returns around earnings announcements measure
Krishnaswami and Subramaniam (1999) use the volatility in abnormal
returns around earnings announcements as the measure of information asymmetry
about each firm. This announcement reaction variable is measured as the standard
deviation of the three-day abnormal returns around the announcement of quarterly
earnings, over all the quarterly earnings announcements during the test period. A
strong positive or negative reaction by the market around an information-revealing
event such as an earnings announcement suggests that information asymmetry is
high for these firms. As in Dierkens (1991), the standard deviation of the abnormal
returns around earnings announcements, which measures the dispersion in the
market reaction, is used as a metric of information asymmetry.

 Residual volatility measure

Residual volatility is measured by the standard deviation of residuals of daily
abnormal stock returns estimated by the market model (Bhagat et al., 1985;
Blackwell et al., 1990; Fee and Thomas, 1999; Clarke and Shastri,2001).
Krishnaswami and Subramaniam (1999) document that information
asymmetry about a firm is high when managers have a relatively large amount of
value-relevant, firm-specific information that is not shared by the market while
investors bear some firm-specific uncertainty until this information is revealed to
the market. Therefore, to the extent that residual volatility reflects uncertainty about
firm’s value among insiders like managers and large shareholders who presumably
are better-informed investors, and outsiders such as retail investors, there should be
a positive relationship between this proxy and asymmetric information.

2.1.2. Overview of the cost of equity capital

2.1.2.1. Definitions of the cost of equity capital

- Ross, Westerfield and Jordan (2002) have defined cost of equity as “the
return that equity investors require on their investment in the firm”. While firms
 16

need to acquire capital from others to operate and grow, individuals and
organizations who are willing to allocate their funds to others naturally desire to be
rewarded.
- To be more specific, Botosan (2006) argues that cost of equity capital can
also be described as the minimum rate of return equity investors require for
providing capital to the firm which is comprised of the risk free rate of interest and
a premium for the firm's non-diversifiable risk; or be defined as the risk-adjusted
discount rate that investors apply to expected future cash flows to arrive at current
stock price. Additionally, Botosan also claims that cost of equity capital is
sometimes referred to as the expected cost of equity capital because it is a forward-
looking concept, which is not directly observable in the market place.

2.1.2.2. Measuring cost of equity capital

In fact, in the absence of a directly observable measure, cost of equity capital
must be estimated by a number of approaches. There are two main approaches that
are often used by empiricists and discussed in detail as follows.

 Based on asset pricing models

One of the most common methods is to use predetermined priced risk factors
to yield explicit estimates of cost of equity capital.
 Capital Asset Pricing Model (CAPM)
The capital asset pricing model (CAPM) of William Sharpe (1964) and John
Lintner (1965) defines cost of equity capital as the risk free rate plus the market's
expected risk premium (Et (rm – rf)) multiplied by the company's amount of risk as
measured by market beta (). In other word, cost of equity or re can be calculated as
follows:
re  r f    Et rm  r f 
Although this approach is popular in practice, its widespread use is not
without controversy. The CAPM approach requires that two things be estimated, the
market risk premium and the beta coefficient. Users of the CAPM often employ the
historical premium as a proxy for the expected value, but this imposes inter-
temporal stability assumptions that may not be descriptive. Moreover, the
 17

magnitude of the historical risk premium is in dispute, as it is sensitive to the period

examined and the risk-free rate employed. Furthermore, estimating a firm's market
beta is similarly confronted with difficulties. Estimates of the company's historical
market beta are sensitive to a number of factors including the estimator's choice of
market index, return interval, and estimation period. To the extent that our estimates
are poor, the resulting cost of equity will be inaccurate (Botosan, 2006).
Moreover, Fama and French (2004) claim about the validity of CAPM
because the empirical record of the model is poor enough to invalidate the way it is
used in applications. The CAPM’s empirical problems may reflect theoretical
failings, the result of many simplifying assumptions. More importantly, in the late
1970s, research begins to uncover variables like size, various price ratios and
momentum that add to the explanation of average returns provided by beta. In light
of this, it is now fairly well-accepted that risk factors other than market beta are
priced, especially in some multi-factor model like Fama–French three-factor
model.
 Fama– French three-factor model
Fama and French (1995) three-factor model expands the set of risk factors to
include the risks captured by firm size and market-to-book. By combining the
original market risk factor and the newly developed factors, this model describes the
expected return as a result of its relationship to three risk factors: market risk, size
risk, and “value” risk:
rA = rf + A(rm –rf)+ sA SMB+ hA HML
Unfortunately, the three-factor model encounters the same estimation
problems as the CAPM model. For example, Levhari and Levy (1977) show that
beta coefficients estimated with monthly returns are not the same as betas estimated
with annual returns. Horowitz et al. (2000) suggest that the size effect is not robust
across different sample periods and argue that it may have disappeared since 1982.
In addition, there are many questions raised about whether even this model is
complete.
 18

 Summary
Taking into consideration both of CAPM and other multifactor models,
Botosan (2006) asserts that the resulting cost of equity capital estimates based on
these methods are not useful to empiricists investigating the link between
information asymmetry and cost of equity capital. Because these models assume
that the priced risk factors are known and limited to the factors in the model, the
nature of the empirical relation between information asymmetry and cost of equity
capital is predetermined. If the model does not include asymmetric information as a
priced risk factor, the relevant question becomes whether disclosure is related to any
of the factors that are in the model, which cannot contain much empirical
significance.

 Implied cost of equity approach

The second approach empiricists often use to estimate cost of equity is the
implied cost of equity method. This approach assumes a valuation model and infers
cost of equity using equity price and other variables in the model (such as future
cash flows).
 Residual Income Model (RIM) method
Gebhardt, Lee, and Swaminathan (2001) calculate the implied cost of capital
using the Residual Income Model (RIM). This model is algebraically equivalent to
the familiar dividend discount model but provides better intuition on the role of
economic profits on stock valuation. The residual income approach offers both
positives and negatives when compared to the more often-used dividend discount
and DCF methods. On the plus side, residual income models make use of data
readily available from a firm's financial statements and can be used well with firms
who do not pay dividends or do not generate positive free cash flow. Most
importantly, residual income models look at the economic profitability of a firm
rather than just its accounting profitability. The biggest drawback of the residual
income method is the fact that it relies so heavily on forward looking estimates of a
firm's financial statements, leaving forecasts vulnerable to psychological biases or
historic misrepresentation of a firms financial statements.
 19

According to the dividend discount model, the stock price is the present
value of its expected future dividend (free cash flows to equity):


Et d t i 
Pt  
i 1 1  re i (2.1)

Where:
Pt is the current stock price;
Et (Dt+i) is the expected future dividends for period t+i conditional on
information available at time t;
re is the cost of equity based on the information set at time t.
Provided that a firm’s earnings and book value are forecast in a manner
consistent with “clean surplus accounting” which requires the change in book value
from period to period is equal to earning minus net dividends, the equation (2.1) can
be written as the reported book value, plus an infinite sum of discounted residual
income as follows:

Et Bt i 1 ROE t i  re 
Pt  Bt  
i 1 1  re i
Where:
Bt is book value at time t;
Et [.] is expectation based on information available at time t;
re is cost of equity capital;
ROEt+i is the after-tax return on book equity for period t+i.
Therefore, the researcher can thus solve for the cost of equity from the
equation above using current stock price, current book value of equity, and forecasts
of future ROE and book value of equity.
 Price-earnings growth method
Based on the meaning of PEG ratio (which is the price-earnings [PE] ratio
divided by the short-term earnings growth rate), Easton (2004) builds valuation
model of equity price as a function of earnings and earnings growth and provides an
 20

empirical means of simultaneously estimating the expected rate of return and the
rate of change in abnormal growth in earnings beyond the short forecast horizon.
Starting with a no-arbitrage assumption and assuming a perpetual rate of
change in abnormal growth in earnings, Easton (2004) derives the following
equation for equity price:
𝐸𝑃𝑆𝑡+1 𝐴𝐺𝑅𝑡+1
𝑃𝑡 = +
𝑟 𝑟(𝑟 − ∆𝐴𝐺𝑅)
Where:
𝐴𝐺𝑅𝑡+1 = 𝐸𝑃𝑆𝑡+2 + 𝑟 ∗ 𝐷𝑃𝑆𝑡+1 − (1 + 𝑟)𝐸𝑃𝑆𝑡+1 is the expected abnormal
growth in accounting earnings;
EPSt+1 is the EPS forecast in year t + 1;
DPSt+1 is the expected dividends per share;
r is the expected return;
ΔAGR is the perpetual rate of change in AGR.
Rearranging terms, we have
𝐶𝐸𝑃𝑆𝑡+2 𝐸𝑃𝑆𝑡+1
= 𝛾0 + 𝛾1 + 𝑒𝑡
𝑃𝑡 𝑃𝑡
where γ0= r (r − ΔAGR) and γ1 = (1 + ΔAGR) and CEPSt+2 is the cum-dividend EPS
forecast in year t+ 2.
Hence, the following regression can be used to estimate the parameters:
𝐶𝐸𝑃𝑆𝑖,𝑡+2 𝐸𝑃𝑆𝑖,𝑡+1
= 𝛾0 + 𝛾1 + 𝑒𝑖𝑡
𝑃𝑖𝑡 𝑃𝑖𝑡
In the regression, γ0 = r (r− ΔAGR) and γ1 = (1 + ΔAGR), and we can solve
for r and ΔAGR with the estimates of γ0 and γ1.
Following this model, Botosan (2013) imposes several simplifying
assumptions including zero dividends before the forecast horizon and zero growth
in abnormal earnings (i.e., earnings beyond a charge for equity capital) beyond the
forecast horizon and rearrange terms yields the formula for cost of equity capital
that is shown in the following equation:

𝐸𝑃𝑆2 − 𝐸𝑃𝑆1
𝑟𝑃𝐸𝐺 = √
𝑃0
 21

Additionally, Easton (2004) contends that key elements of his model are
very similar to the key elements of the Residual Income Valuation model that
has been discussed above. However, Ohlson (2001) has pointed out that a
possible limitation of RIM approach is that it relies on the clean-surplus
assumption in the forecast of future book values and this assumption rarely
holds a practical matter. In addition, the terminal growth rate is often arbitrary in
the empirical models and this brings further estimation errors (Berger, Chen and Li,
2005).
 Summary
In general, the estimates produced by this stream of literature have proven
more useful to researchers investigating the link between information asymmetry
and cost of equity capital than the estimates discussed previously. It is established in
the literature that at least two of the models produce estimates that capture cross-
sectional variation in risk in a predictable manner (Botosan and Plumlee, 2005),
which is an important first step in establishing construct validity. Moreover, these
estimates are not a function of a predetermined set of priced risk factors, which
makes them particularly useful to researchers endeavoring to establish whether a
particular type of risk is priced (Botosan, 2006).

2.1.3. Theoretical bases of the impacts of information asymmetry on cost of equity

capital
It is apparent that although some traditional asset-pricing models like Fama
and French (1992) admit the possibility that something other than market risk may
affect required returns, these alternative factors do not include the role of
information. Recently, one of the most salient researches investigating the role of
information in affecting a firm’s cost of capital is the study conducted by Easley
and O’Hara (2004). By developing a multi-asset rational expectations equilibrium
model that includes public and private information, and informed and uninformed
investors, Easley et al. (2004) demonstrate the expected return per share for stock k
as follows:
 22

̅̅̅̅
𝛿𝑥 𝑘
𝐸 [𝑣𝑘 − 𝑝𝑘 ] = (2.2)
𝜌𝑘 +(1−𝛼𝑘 )𝐼𝑘 𝛾𝑘 +𝜇𝑘 𝛼𝑘 𝐼𝑘 𝛾𝑘 +(1−𝜇𝑘 )𝜌𝜃𝑘

Where:
xk is the per-capita supply of stock k and is normally distributed with mean ̅̅̅
𝑥𝑘
and precision 𝜂𝑘 ;
𝑣𝑘 is future value of stock k and is normally distributed with mean ̅̅̅̅̅
𝑣𝑘 and
precision 𝜌𝑘 ;
𝑝𝑘 is the today price of stock k and is determined in the market;
𝐼𝑘 is the number of signals that investors receive today about the future value
of stock k; these signals are distributed normally with mean 𝑣𝑘 and precision 𝛾𝑘 ;
𝛼𝑘 is the fraction of the signals about the value of stock k that is private;
𝜇𝑘 is the fraction of traders who receive the private signal about stock k.
This model shows that the return depends on the information structure, with
the levels of public and private information influencing the cross-sectional
equilibrium return demanded by investors. They also prove that if private signals
are truly private to some traders (µk < 1), then the required return is increasing in αk,
the fraction of the signals about stock k that are private. In other words, when
comparing two stocks that are otherwise identical, the stock with more private and
less public information will have a larger expected excess return. This occurs
because when information is private, rather than public, uninformed investors
cannot perfectly infer the information from prices, and consequently they view the
stock as being riskier. In short, they have demonstrated that investors demand a
higher return to hold stocks with greater private information because informed
investors are better able to shift their portfolio weights to incorporate new
information and pose a risk to uninformed investors. This conclusion also set a solid
foundation for the theoretical link between information asymmetry and cost of
capital.
However, the Easley and O’Hara (2004) model then came under attack by
some critics. Lambert, Leuz and Verrecchia (2008) analyze how the distribution of
information across investors affects firms’ cost of capital and demonstrate that
Easley and O’Hara’s (2004) interpretation of their model and the role of
 23

information asymmetry is not correct. To be more specific, they argue that the
expression on the right-hand-side of equation (2.2) is simply the average precision
of information across investors. In other words, it is the average precision of
information that determines the magnitude of the discount relative to the expected
cash flow, not being driven by information asymmetries as in Easley and O’Hara
(2004) model. Thus, Lambert et al. (2008) conclude that contrary to the suggestion
in Easley et al. (2004), price is not discounted because less informed investors face
an adverse selection problem and price protect themselves. Instead, price is
discounted because less informed investors have more uncertainty about the end-of-
period cash flow, which reduces the average precision of information across
investors in the economy. In fact, increasing the degree of information asymmetry
between investors can reduce the cost of capital, provided that the average precision
increases. Moreover, an implication of this analysis is that information asymmetry
is a separate and distinct effect from information precision effect, and both
contribute to a firm’s cost of capital in unique ways.
Taking into account both of these theoretically important findings, it can be
noted that information plays an important role in determining cost of equity capital.
As a result, the relation between information asymmetry and cost of equity capital
has received considerable attention among academics from both theoretical and
empirical perspectives throughout the world with different conclusions. These
studies will be summarized in the next part to get the whole picture of this crucial
academic issue.

2.2. Prior researches examining the link between asymmetric information and
cost of equity capital

2.2.1. Supporters of the positive association between asymmetric information and

cost of equity capital
On the one hand, there seems to be broad consensus both in the theoretical
and empirical literature that greater information asymmetry increase cost of equity
capital.
 24

2.2.1.1. Theoretical literature

 Earlier economic theory suggests that, ceteris paribus, increasing the quality
of financial information or reducing information asymmetries can lower the cost of
capital (e.g. Myers and Majluf (1984), Barry and Brown (1985, 1986), Merton
(1987), Amihud and Mendelson (1986), Diamond and Verrecchia (1991)).
Assuming management in firms knows more about the firm’s value than
potential investors, Myers and Majluf (1984) point out that if this information
asymmetry cannot be resolved, such firms will view making public equity or debt
offers to be costly for existing shareholders. Consequently, managers who
anticipate making capital market transactions have incentives to provide voluntary
disclosure to reduce the information asymmetry problem, thereby reducing the
firm’s cost of external financing.
After that, Barry and Brown (1985, 1986) and Merton (1987) reach a similar
conclusion by modeling the premium that investors demand for bearing information
risk when there is an information asymmetry between managers and outside
investors. Managers can reduce their cost of capital by reducing information risk
through increased voluntary disclosure.
Moreover, empirical work by Amihud and Mendelson (1986) suggests that
firms whose stocks have a higher bid-ask spread have a higher cost of equity capital
because investors demand compensation for the added transaction costs. The
authors contend that firms that provide more public information can reduce the
adverse selection component of the bid-ask spread, and thus reduce their cost of
equity capital.
Diamond and Verrecchia (1991) suggest that higher disclosure reduces the
amount of information revealed by a large trade in a firm’s securities, thereby
reducing the negative price impact associated with such large trades. In this
scenario, investors would have relatively large positions in a particular firm’s
securities. There would be a higher demand for the firm’s securities, which would
increase the price of the firm’s stock, thereby reducing the equity cost of capital.
 25

 Recent literature have continued to prove the positive relationship between

information asymmetry and cost of capital (e.g. Easley and O’Hara (2004), Leuz
and Verrecchia (2004)).
Based on the classic rational expectations analysis of Grossman and Stiglitz
(1980), Easley and O’Hara (2004) have developed an asset pricing model that
suggest that information asymmetry affects prices and is a determinant of firms’
cost of capital. As analyzed detailed in the part 2.1.3, this research demonstrates that
because of information asymmetries, differentially informed traders will choose to
hold different portfolios of securities and implies that investors demand a higher
return to hold stocks with greater private information. This higher return reflects the
fact that private information increases the risk to uninformed investors of holding
the stock because informed investors are better able to shift their portfolio weights
to incorporate new information. In this model, required returns are affected by both
the quantity of private information with more private information increasing the
required returns of the uninformed and by the precision of both the public and
private information, with higher precision reducing expected returns.
Taking a different approach, Leuz and Verrecchia (2004) consider the role
of performance reports (e.g. earnings) in aligning firms and investors with respect to
capital investments. Nevertheless, this research still reach the same conclusion that
is higher information quality increases expected cash flows, which in turn reduces
the firm’s cost of capital. Poor information quality leads to misaligned capital
investment by the firm, which rational investors anticipate and price in equilibrium
by discounting firms’ expected cash flows at a higher rate of return. Leus and
Verrecchia (2004) extend the literature in providing a direct link between
information quality and cost of capital that does not rely on liquidity or shareholder
base effects.

2.2.1.2. Empirical literature

Based on the above theoretical background, across different countries and
stages of economic development, evidence has accumulated that greater information
asymmetry among active traders of a particular stock increases the company’s cost
of capital.
 26

Examining in the US market, Kelly and Ljunqvist (2012) provide direct

evidence of the importance of information asymmetry for asset prices and investor
demands using plausibly exogenous variation in the supply of information caused
by the closure or restructuring of brokerage firms’ research operations. They
conclude that consistent with predictions derived from a Grossman and Stiglitz
model, share prices and uninformed investors’ demands fall as information
asymmetry increases.
Petrova et al. (2012) adopts a finite horizon version of the residual income
valuation model for a sample of 121 Swiss listed, non-financial companies to
demonstrate that firms on the Swiss market can reduce their cost of equity capital
by increasing the level of their voluntary corporate disclosures or decreasing
information asymmetry. The results persist even after controlling for various firm
specific risks, such as firm size or financial leverage and regardless of company’s
reporting strategy.
Turning to Asian countries, Choi, Jin, and Yan (2013) use daily institutional
ownership data from the Shanghai Stock Exchange to demonstrate that
institutions have an information advantage in the Chinese stock market, and the
stronger this advantage is for a given stock, the higher is the stock’s
expected return. This cross-sectional relationship is consistent with the model of
Easley and O’Hara (2004), suggesting that companies could decrease their cost
of capital by leveling the informational playing field among their investors.

2.2.2. Critics of the positive association between asymmetric information and cost
of equity capital
On the other hand, in some researches, the relationship between information
asymmetry and cost of equity capital also remains inconclusive from both a
theoretical and an empirical perspective.

2.2.2.1. Theoretical literature

One critical stream of the literature, mainly composed by financial
researchers, defends that the effect of information asymmetry can be diversified,
and thus cannot affect the cost of equity (e.g. Hughes, Liu and Liu (2005), Lambert,
Leuz, and Verrecchia (2006), Core, Guay and Verdi (2008)).
 27

Hughes, Liu and Liu (2005) show that in a large economy, the effect of
asymmetric information on expected returns is diversifiable. They argue that
asymmetric information is priced in Easley and O’Hara (2004) because the number
of assets in their model is finite and hence asymmetric information risk cannot be
diversified away. In spite of the fact that private information should be diversifiable
in a large economy, empirically a proxy for information asymmetry, private
information, is positively and significantly related to average stock returns.
This conclusion is further supported by Lambert, Leuz, and Verrecchia
(2006) who note that increasing the degree of information asymmetry between
investors can reduce the cost of capital, provided that the average precision
increases. Thus, the dissemination of more information to more investors can drive
down the cost of capital because it increases the average precision of investors, not
because it reduces information asymmetries as Easley and O’Hara (2004) claim.
Furthermore, Core, Guay and Verdi (2008) test Lambert, Leuz and Verrecchia’s
(2006) prediction that asymmetric information effects should be diversified away,
and empirically document that accruals quality is not a priced risk factor.
Armstrong, Banerjee, and Corona (2008) also consider a multi-firm model
where information quality affects cost of capital through systematic risk. They show
that both systematic and firm-specific information quality decrease expected returns
for positive beta stocks but increase expected returns for negative beta stocks, which
is the “beta” effect of information quality. They also note that the convexity effect
of systematic information quality unambiguously increases expected returns, by
lowering aggregate uncertainty and hence increasing the risk-free rate.
Another problem, noted by Christensen, De la Rosa, and Feltham (2008), is
that if there are no real decisions, disclosure should only affect the timing of
resolution of uncertainty, and thus a commitment to disclosure does not increase
welfare of the manager disclosing or, even, that of investors.
Furthermore, Duarte and Young (2007) decompose the private information
(PIN) measure into two components, one related to asymmetric information and one
related to illiquidity. Using a two-pass Fama-MacBeth regression, they show that
the PIN component related to asymmetric information is not priced, while the PIN
 28

component related to illiquidity is priced and hence, conclude that liquidity effects
unrelated to information asymmetry explain the relation between PIN and the cross-
section of expected returns.
2.2.2.2. Empirical literature
Consistent with the contradictory theoretical views, the empirical works also
find mixed or different conclusions of a negative relation between cost of equity
capital and information disclosure, or the positive association between information
asymmetry and cost of equity.
Botosan (1997) finds no evidence of a relationship between information
disclosure and the cost of capital for her full sample of firms and only weak
evidence of a negative relationship for the sub-sample of firms with low analyst
coverage.
Botosan and Plumlee (2002) show that only the sub-component of AIMR
scores related to annual report disclosures has a modest negative association with
the cost of capital and this relation varies across different disclosure measures. To
be more specific, Botosan and Plumlee (2002) find that the cost of equity decreases
in the annual report disclosure level but increases in the quarterly report disclosure
level and they find no association between the cost of equity capital and the level of
investor relation activities. Their interpretation is that this result is consistent with
concerns expressed by financial executives and others about the effect of timely
disclosures on the cost of capital through stock price volatility. Results documented
by Bushee and Noe (2000) also provide empirical evidence for this conclusion by
asserting that disclosure also attracts transient investors, which exacerbate a firm’s
stock return volatility with their short investment horizons and aggressive trading
strategies. In addition, all else being equal, an increase in volatility leads investors
to demand higher returns from their shares as compensation for the added risk.
From the perspective of the corporation,this translates into a higher cost of capital
that must be used when evaluating prospective investments, thus reducing the
aggregate level of investment (Froot, Perold and Stein, 1992).
Richardson and Welker (2001) investigate the relation between two types of
disclosure (social and financial disclosures) and the cost of capital for a sample of
 29

Canadian firms within three years 1990-1992. They find that the financial
disclosure is negatively related to the cost of equity capital for firms with low
analyst following. However, contrary to their expectations, they document a
significant positive relation between social disclosures and the cost of equity.
Likewise, Francis et al. (2008) show that the cost of equity is negatively
related to the disclosure measure based on annual reports and 10-K filings,
positively related to disclosure measures based on management forecasts and
conference calls, and unrelated to press-release based disclosure measures.
Furthermore, Gomes et al. (2005) investigate the effects of Regulation Fair
Disclosure (Reg FD) adopted by the U.S. Securities and Exchange Commission in
October 2000 which was intended to stop the practice of selective disclosure on cost
of capital of US firms. Theirs analysis shows that the adoption of Reg FD caused a
significant shift in analyst attention, resulting in a welfare loss for small firms,
which now face a higher cost of capital. This empirical result is also in contrast to
the positive effect of information asymmetry on cost of equity.
 30

CHAPTER 3: RESEARCH METHODOLOGY

3.1. Research design
The mixed theoretical and empirical evidences summarized in the previous
part leads this research to examine the following two hypotheses:
H1: There is a positive association between information asymmetry and cost of
equity.
H2: There is a negative association between information asymmetry and cost of
equity.
To test both of these hypotheses, the researcher will build a regression model
to investigate the association between information asymmetry and cost of equity
capital during the one-year period of 2013. Following Botosan (1997), Botosan &
Plumlee (2002), Hail (2002), Leuz & Hail (2006), Botosan & Plumlee (2013) this
study will employ three control variables that are market beta, firm size and book-
to-market. The formulation of regression will be represented in detail as follow:
𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝐼𝐴𝑆𝑖 + 𝑈𝑖
Where:
𝐶𝑂𝐶𝑖 is the dependant variable which estimate the cost of equity capital for
company i;
𝑆𝐼𝑍𝐸𝑖 , 𝐵𝐸𝑇𝐴𝑖 , and 𝐿𝐵𝑀𝑖 are control variables of company i which
describe firm size, market beta and book-to-market ratio respectively;
𝐼𝐴𝑆𝑖 is the level of information asymmetry for company i which is estimated
by some proxies.
Regarding to the proxies for information asymmetry, due to the fact that in
young Vietnamese stock market, there is a lack of earnings forecast services
provided by analysts as in the developed financial markets as well as there is a
shortage of official and updated information system, some proxies for estimating
information asymmetry like analysts ‘earnings forecasts or investment opportunities
sets cannot be employed. Therefore, to estimate the information asymmetry, this
research will use three proxies which are: adverse selection cost, earnings
management proxy and residual volatility. Furthermore, the researcher will run
 31

regression of cost of equity on each proxy for information asymmetry or the

following three models:
Model 1: 𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝐷𝐴𝑆𝐶𝑖 + 𝑈𝑖
Model 2: 𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝐴𝐵𝑆_𝐷𝐴𝐶𝐶𝑖 + 𝑈𝑖
Model 3: 𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝑅𝑆𝐷𝑖 + 𝑈𝑖
Where:
𝐷𝐴𝑆𝐶𝑖 is the adverse selection cost of stock i;
𝐴𝐵𝑆_𝐷𝐴𝐶𝐶𝑖 is the absolute value of discretionary accruals which is a proxy
for earnings management of company i;
𝑅𝑆𝐷𝑖 is the residual volatility of stock i during 2013.
For each regression model, OLS regression is used to obtain the regression
result and to analyze the model in terms of the significance of coefficient, goodness-
of-fit, the correlation between variables before testing some OLS assumptions of
each model to examine the hypothesis this research developed.

3.2. Measurements of variables

3.2.1. Dependant variable - cost of equity capital
As discussed in the second chapter, the implied cost of capital approach is
more useful for researchers to investigate the link between information asymmetry
and cost of equity capital. Therefore, following Lee et al. (1999) and Gebhardt et al.
(2001), this research will choose the Residual Income Valuation Model (RIM) in
order to compute the implied cost of equity capital. The intrinsic value of a
company's stock using a the residual income approach can be broken down into its
book value and the present values of its expected future residual incomes and can be
illustrated in the following model:

Et Bt i 1 ROE t i  re 
Pt  Bt   (3.1)
i 1 1  re i
Where:
Bt is book value per share at time t;
Et [.] is expectation based on information available at time t;
re is cost of equity capital;
 32

ROEt+i is the after-tax return on book equity for period t+i.

Equation (3.1) expresses firm value in terms of an infinitive series, however,
for practical purposes, a finite forecast horizon and terminal value must be
estimated. In many studies of developed countries, the forecast period can be up to
5 years due to the advantages of information environment with earnings forecast
services provided by analysts. Nevertheless, in Vietnam, because of a lack of these
advantageous conditions, choosing a long forecast period with simple growth
assumptions can lead to inaccurate results. Therefore, the forecast period used in
this research is 2 years. After the two-year period, the residual income is assumed to
persist in perpetuity to estimate the terminal value. With these assumptions, RIM
will be shortened as follows:

xta1 xta 2 xta 2

Pt  Bt   
1  re 1  re 2 re 1  re 2 (3.2)

𝑎 𝑎
where 𝑥𝑡+1 , 𝑥𝑡+2 is the expected residual income in time t+1 and t+2 and is
calculated as xt+1a = xt+1 – re Bt with xt+1 is EPS of stock at time t+1 or EPSt+1
and xt+2a = xt+2 – re Bt+1 with xt+2 is EPS of stock at time t+2 or EPSt+2.
Hence, the equation (3.2) can be rewritten as follows:

EPSt 1  re Bt EPSt  2  re Bt 1 EPSt  2  re Bt 1

Pt  Bt   
1  re 1  re 2 re 1  re 
2 (3.3)

From the equation (3.3), it can be concluded that to estimate the implied cost
of equity (re) the researcher have to conduct a three-stage process as follows: firstly,
forecasting the future earnings (EPSt+1, EPSt+2), secondly, this research will forecast
the expected book value per share Bt+1; and finally, after collecting the stock price
in the end of the first quarter of 2014 and book value per share in the end of 2013,
the quadratic equation will be solved to find out the implied cost of equity (re).
 Stage 1: Forecasting earnings
As analyzed above, in developed countries with developed financial markets,
earnings forecasts is one of the most common services provided by stock analysts
and can be used directly as reliable inputs of the model. However, in Vietnam, this
type of service does not exist in a systematic way. Therefore, empiricists have no
 33

choice but to project earnings by themselves to indentify the intrinsic value of stock.
Another alternative to forecast earnings is using time-series model to estimate.
Nevertheless, these models require the earnings data during a long period in the
past, which is impractical for the 14-year-old stock market like Vietnam.
Thus, in this research, instead of directly forecasting earning, the researcher
will estimate the sustainable growth rate during the forecast horizon to project
earnings. Following Bodie Z., Kane A. và Markus A. (2003), sustainable growth
rate or expected growth rate will be calculated as g = pb * ROE where g is expected
growth rate of earnings; pb is plowback ratio or earnings retention ratio which can
be expressed as (1- dividend payout ratio).
To be more specific, in order to estimate the implied cost of equity capital at
the end of the first quarter of 2014 (because it is time for all companies to release
their audited financial statements of 2013), this research will collect the data of
book value per share (Bt), earnings per share (EPSt) and dividend per share (DPSt)
of all stocks in this sample during the 4-year period from 2010 to 2013. After that,
the researcher will compute ROE and payout ratio of each stock for each year from
2010 to 2013 based on these data before reaching the average value of these
̅̅̅̅̅̅̅𝑡 , 𝑝𝑎𝑦𝑜𝑢𝑡
variables ( 𝑅𝑂𝐸 ̅̅̅̅̅̅̅̅̅̅̅𝑡 ) . Finally, the expected growth rate of earnings will be
estimated as follows:
̅̅̅̅̅̅̅𝑡
̅̅̅̅̅̅̅̅̅̅̅𝑡 )𝑅𝑂𝐸
𝑔 = (1 − 𝑝𝑎𝑦𝑜𝑢𝑡
Using the expected growth rate g, the expected earnings in time t+1 and
t+2 or in 2014 and 2015 can be calculated as follows:
EPSt+1 = EPS2014 = EPS2013*(1+g)
EPSt+2 = EPS2015 = EPS2014*(1+g)
 Stage 2: Forecasting book value
Forecasting book value is based on the link between book value, earnings
and dividend (clean surplus relation). To simplify, this research will assume the
expected dividend payout ratio during the forecast period will be stable and be
estimated as the average value of the payout ratio in the 4-year period from 2010 to
̅̅̅̅̅̅̅̅̅̅̅𝑡 ):
2013 (𝑝𝑎𝑦𝑜𝑢𝑡
 34

Bt 1  Bt  x t 1  d t 1
 Bt  x t 1  x t 1
 Bt  x t 1 1   
Where xt is EPSt and δ is 𝑝𝑎𝑦𝑜𝑢𝑡
̅̅̅̅̅̅̅̅̅̅̅𝑡 or expected payout ratio.
 Stage 3: Solving the quadratic equation to find out the implied cost of
equity (re)
After estimating the future earnings (EPSt+1, EPSt+2) and future book value
per share Bt+1 in the previous steps, the stock price in the end of the first quarter of
2014 will be collected as a proxy for intrinsic value of stock in the model (Pt). Then,
the equation (3.3) will be solved to find out the implied cost of equity (re). More
specifically, after conducting some rearranging steps, equation (3.3) can be
rewritten as a quadratic equation as follows:
𝑃𝑡 𝑟𝑒2 + (𝑃𝑡 − 𝐸𝑃𝑆𝑡+1 + 𝐵𝑡+1 − 𝐵𝑡 )𝑟𝑒 − 𝐸𝑃𝑆𝑡+2 = 0 (3.4)
The implied cost of equity (re) will be the positive root of the quadratic
equation (3.4). This research will show in detail the estimate of the cost of equity
capital for one firm in the Appendix 1.
3.2.2. Independent variables- Information asymmetry proxies

3.2.2.1. Adverse selection cost

As discussed in the theoretical part, to measure the adverse selection cost,
there are many models established by researchers. This research will choose
Glosten and Harris (1988) model to calculate the adverse selection component and
use it as a proxy of information asymmetry because of a lack of relevant data for
other models. This model is illustrated as follows: (3.5)
𝑃𝑡 − 𝑃𝑡−1 = 𝑐0 (𝑄𝑡 − 𝑄𝑡−1 ) + 𝑐1 (𝑄𝑡 𝑉𝑡 − 𝑄𝑡−1 𝑉𝑡−1 ) + 𝑧0 𝑄𝑡 + 𝑧1 𝑄𝑡 𝑉𝑡 + 𝜀𝑡
Where:
Pt and Pt-1 is the observed transaction price at time t and t-1;
Vt and Vt-1 is the volume or the number of shares traded in the transaction at
time t and t-1;
Qt is a trade indicator that is +1 if the transaction is buyer initiated and –1 if
the transaction is seller initiated;
 35

c0, c1, z0, z1 are the coefficients of the model and 𝜀𝑡 is statistical error.
Glosten and Harris (1988) did not have quote data and, thus, were unable to
observe Qt. Having both trade and quote data, this research will use the Lee and
Ready (1991) and Serednyakov (2005) procedure to classify trades as either buyer-
initiated or seller-initiated as follows:
- Qt is +1 if at transaction time t we have Pt > Pt-1
- Qt is - 1 if at transaction time t we have Pt < Pt-1
- Qt is equal to Qt-1 if at transaction time t we have Pt =Pt-1
According to Ness et al (2001), a unique characteristic of Glosten and Harris
(1988) model is that they decompose bid-ask spread into two parts: the adverse
selection component, Z0, and the combined order processing and inventory holding
component, C0 and express both of them as linear functions of transaction volume.
After using OLS regression to obtain estimates for c0, c1, z0, and z1 for each
stock in the sample, the researcher will calculate the adverse selection component is
Z0 = 2(z0 + z1 Vt) and the order processing/inventory holding component is
C0=2(c0 + c1Vt).
To estimate the adverse selection component as a proportion of the spread,
Glosten and Harris (1988) use the average transaction volume for stock i as follows:
2 (𝑧0 + 𝑧1 𝑉̅𝑡 )
𝐴𝑆𝐶 =
2(𝑧0 + 𝑧1 𝑉̅𝑡 ) + 2(𝑐0 + 𝑐1 𝑉̅𝑡 )
where ASC is adverse selection component of spread; and 𝑉̅𝑡 is the average
transaction volume for stock i.
Moreover, in this research, following Ness et al. (2001), and Brennan and
Subrahmanyam (1995), the researcher will use the adverse selection cost of
transacting computed by dividing the dollar adverse selection component as a
percentage of the stock price as a proxy for information asymmetry. To be more
specific, the formula of the adverse selection cost of transacting as follows:
𝐷𝐴𝑆𝐶 = 2 (𝑧0 + 𝑧1 𝑉̅𝑡 )⁄𝑃̅𝑡 (3.5)

where DASC is the adverse selection cost of transacting; and 𝑃̅𝑡 is the average
closing daily price for stock i.
 36

In short, to estimate the adverse selection cost (DASC) for stock i, this
research will take the following steps:
- Step 1: Collecting the daily closing price (Pt) and the transaction volume (Vt)
for stock i during the test period (from 1/1/2013 to 31/12/2013).
- Step 2: Using OLS regression to obtain estimates for c0, c1, z0, and z1 from
the Glosten and Harris (1988) model (3.4) for stock i.
- Step 3: Calculating ̅𝑃𝑡 , 𝑉̅𝑡 before obtaining the value of DASC for stock i
according to the formula (3.5).
The detail process of calculating the adverse selection cost of a firm will be
illustrated in the Appendix 2 accompanied with the summary of DASC of 222 listed
companies in this sample.

3.2.2.2. Earnings management measures

Due to the difficulties in fully and sufficiently collecting the accounting
information from financial statements of listed companies in Vietnamese stock
market during the long period (especially before 2007), this research cannot employ
accruals models which use time-series approach and regression model like Jones
(1991) model or modified Johns model (1995). Hence, the Friedlan (1994) model is
more suitable for this research to measure earnings management.
The basic Friedlan (1994) model documented in the second chapter is:
𝑇𝐴𝐶𝐶𝑡 𝑇𝐴𝐶𝐶0
𝐷𝐴𝐶𝐶𝑡 = −
𝑅𝐸𝑉𝑡 𝑅𝐸𝑉0
Where: DACCt is the discretionary accruals in the test period;
TACCt is the total accruals in the test period;
TACC0 is the total accruals in the benchmark period;
REVt is sales in the test period;
REV0 is sales in the benchmark period.
In this empirical work, the benchmark time is 2012 and the test period is
2013. Therefore, the discretionary accruals of each firm in 2013 can be recalculated
as follows:
𝑇𝐴𝐶𝐶2013 𝑇𝐴𝐶𝐶2012
𝐷𝐴𝐶𝐶2013 = −
𝑅𝐸𝑉2013 𝑅𝐸𝑉2012
 37

In this formula, the total accruals (TACC) are assumed to be equal to net
income before extraordinary items minus cash flow from operations. Therefore, to
measure the discretionary accruals of each firm in 2013, this research will gather the
data of net income, sales and cash flow from operations of each firm in two years
2012 and 2013.
As earnings can be managed up and down based on management discretion
(Bergstresser & Philippon, 2006), the discretionary accruals (DACC) can be
positive (income-increasing discretionary accruals) or negative (income-decreasing
discretionary accruals). Therefore, to reflect the level of earnings management
precisely in relation to information asymmetry and cost of capital, this research will
use the absolute value of DACC (named ABS_DACC) in the regression model.

3.2.2.3. Residual volatility

Krishnaswami and Subramaniam (1999) contend that the residual volatility
or residual standard deviation is the dispersion in the market-adjusted daily stock
returns during the test period. Following Krishnaswami, the researcher will
calculate residual volatility of each firm as the residual standard deviation from a
market model regression, estimated using daily return data over year 2013.
The following market model is estimated for stock i:
ri ,d   i   i rm ,d   i ,d
(3.6)
Where:
𝑃𝑖,𝑑 −𝑃𝑖,𝑑−1
ri,d is the return on stock i on day d, computed as with Pi,d and
𝑃𝑖,𝑑−1

Pi,d-1 are the closing price of stock i on day d and d-1 respectively;
rm,d is the market return on day d or the return on VNINDEX on day d
𝑉𝑁𝐼𝑑 −𝑉𝑁𝐼𝑑−1
computed as ;
𝑉𝑁𝐼𝑑−1

αi,, βi are coefficients and εi,d is the statistical error of the model.
By running OLS regression of model (3.6), the researcher can calculate 𝑒𝑖,𝑑
which is stock i’s residual return on day d.
Hence, after gathering daily residual return in 2013 by using market model,
the residual volatility of stock i (RSDi) will be calculated as the standard deviation
 38

of the daily residuals 𝑒𝑖,𝑑 computed over the year 2013 (from 1/1/2013 to
31/12/2013).
3.2.3. The control variables

3.2.3.1. Firm size (SIZE)

Previous studies have used many measures such as total sales revenue, total
assets, book value equity, or market value of equity as proxy for size of firm.
Following Lougee and Marquardt (2004), Daley (1984) and Foster (1977), this
research will use total asset as a proxy to capture differences in size which can be
collected from the financial statements in 2013 of all companies in this sample.
More importantly, a natural log transformation of the data can be used to mitigate
skewness in the distribution of total asset.

3.2.3.2. Book-to-market ratio (LBM)

Book – to – market ratio is a ratio used to find the value of a company by
comparing the book value of a firm to its market value, or illustrated in the
following formula:
Book Value of Equity
𝐵 ⁄𝑀 =
Market Value of Equity
In this research, Book-to-market ratio is measured by scaling the common
equity of the firm by the market value of equity. Both the numerator and the
denominator of the ratio are measured at the end of year 2013. In other words, the
researcher will collect the book value of equity of each firm from financial
statement of 2013 and calculate the market value of equity by multiplying the
number of outstanding shares and stock price at the end of 2013. Following Botosan
and Plumlee (2013), a natural log transformation of the data can be used to mitigate
skewness in the distribution of book-to-market. In other word, this research will use
LBM = log (B/M) as a control variable in this model.

3.2.3.3. Beta (BETA)

Beta is a measure of the volatility, or systematic risk, of a security or a
portfolio in comparison to the market as a whole. In order to estimate the market
beta (BETA), following many prior researches, a market model will be applied. In
 39

other word, the researcher will regress stock return (ri) against market return (rm) as
in the following regression model:
ri ,d   i   i rm ,d   i ,d
Where:
𝑃𝑖,𝑑 −𝑃𝑖,𝑑−1
ri,d is the return on stock i on day d, computed as with Pi,d and
𝑃𝑖,𝑑−1

Pi,d-1 are the closing price of stock i on day d and d-1 respectively;
rm,d is the market return on day d or the return on VNINDEX on day d
𝑉𝑁𝐼𝑑 −𝑉𝑁𝐼𝑑−1
computed as ;
𝑉𝑁𝐼𝑑−1

αi,, βi are coefficients and εi,d is the statistical error of the model;
BETA can be expressed as slope of regression model and can be calculated
as follows:
𝐶𝑜𝑣(𝑟𝑖,𝑑 , 𝑟𝑚,𝑑 )
𝐵𝐸𝑇𝐴𝑖 =
𝑉𝑎𝑟(𝑟𝑚 )
To be more specific, for each stock this research will use daily closing stock
price and VNINDEX price from 1/6/2013 to 31/12/2013 to calculate BETA.
3.3. Sample selection and data collection
3.3.1. Sample selection
Sampling technique in this research is the purposive sampling. The original
sample consisted of all 303 companies listed on the Ho Chi Minh Stock Exchange
(HOSE) until the beginning of 2014. Following Hail (2002), Petroval et al. (2012),
this sample includes companies from various industries. However, this research
exclude 17 financial companies form banking, insurance, securities sectors, because
their operation business as well as financial statements differs significantly from
other industries. Out of the non-financial companies, 30 companies were dropped
because they have not published financial reports with sufficient financial
information consistently during the 4-year period from 2010 to 2013 that will be
used to estimate variables such as cost of equity capital or the firm size. Finally,
after estimating the implied cost of equity by solving quadratic equations, this
research excludes 34 companies that are estimated to have the negative or unreal
 40

value of cost of equity. Finally, the sample consists of 222 non-financial that satisfy
the above specified criteria.
3.3.2. Data collection
Based on the methods applied to measure all variables in this model, the
researcher will collect two types of raw data as follows:
- The first type is data of daily closing stock price, volume transaction and
VNINDEX price from 1/1/2013 to 31/12/2013 that will be gathered from the
website http://www.fpts.com.vn/ in order to measure variables like adverse
selection cost, residual volatility, book –to- market, beta, cost of equity.
- The second type is data of financial information of financial statements like
total asset, sales, EPS, book value of equity… during the period from 2010 to 2013
which will be collected from public financial reports of listed companies on their
official website or on the website http://cafef.vn. These data will be used to measure
some variables like earnings management proxy, cost of equity, firm size and book-
to-market.
In short, the sources and methods of collecting data to measure all variables
in this model will be summarized in the two following tables:
 41

Table 3-1 Summary of data sources

Variables Description Raw data needed and sources

- EPS, book value of equity, number of
outstanding shares, dividend paid from 2010
Estimated cost of to 2013 (source: audited financial reports,
COC cafef.vn)
equity capital
- Stock price in the end of the first quarter of
2014 (source: http://www.fpts.com.vn )

- Daily stock price, transaction volume from

Adverse selection
DASC 1/1/2013 to 31/12/2013
transaction cost
(source: http://www.fpts.com.vn )

Absolute value of - Total asset, net income, sales, cash flow

ABS_DACC discretionary from operation in 2012, 2013
accruals (source: audited financial reports, cafef.vn)

- Daily stock price, VNINDEX price from

Residual
RSD 1/1/2013 to 31/12/2013
volatility
(source: http://www.fpts.com.vn )

- Total asset in 2013 (source: audited

SIZE Firm size
financial reports, cafef.vn)
Daily stock price, VNINDEX price from
BETA Market beta 1/6/2013 to 31/12/2013

(source: http://www.fpts.com.vn)

Book value of equity, number of outstanding

Logarithm of
LBM shares, tock price in the end of 2013 (source:
Book – to market
audited financial reports, cafef.vn)
 42

Table 3-2 Summary of data measurement process

Variables Description Measurement process

_ Forecast the future earnings (EPSt+1,
EPSt+2) by calculating growth rate g.
Estimated cost of - Forecast the expected book value per
COC
equity capital share Bt+1.
- Solve the quadratic equation to find out
the implied cost of equity (re).
- Collect the daily closing price (Pt) and
the transaction volume (Vt) and identify Qt
during 2013.
Adverse selection - Using OLS regression to obtain estimates
DASC
transaction cost for c0, c1, z0, and z1 from the Glosten and
Harris (1988) model for stock i.
- Calculating ̅𝑃𝑡 , 𝑉̅𝑡 before obtaining the
value of DASC for stock i.
𝐴𝐵𝑆_𝐷𝐴𝐶𝐶2013 = |𝐷𝐴𝐶𝐶2013 |
Absolute value of
𝑇𝐴𝐶𝐶2013 𝑇𝐴𝐶𝐶2012
ABS_DACC discretionary =| − |
𝑅𝐸𝑉2013 𝑅𝐸𝑉2012
accruals
Where 𝑇𝐴𝐶𝐶𝑡 = 𝑁𝐼𝑡 − 𝐶𝐹𝑂𝑡
RSD is the standard deviation of the daily
residuals 𝑒𝑖,𝑑 computed over the year 2013
RSD Residual volatility (from 1/1/2013 to 31/12/2013) of the
regression market model:
ri ,d   i   i rm ,d   i ,d

SIZE Firm size 𝑆𝐼𝑍𝐸 = log(𝑇𝑂𝑇𝐴𝐿 𝐴𝑆𝑆𝐸𝑇)

𝐶𝑜𝑣(𝑟𝑖,𝑑 , 𝑟𝑚,𝑑 )
BETA Market beta 𝐵𝐸𝑇𝐴𝑖 =
𝑉𝑎𝑟(𝑟𝑚 )

𝐿𝐵𝑀 = log(𝐵⁄𝑀)
Logarithm of Book Value of Equity
LBM = log( )
Book – to -market Market Value of Equity
 43

3.4. Expected results

It is expected that the result would indicate the effects of three control
variables and proxies for information asymmetry on cost of equity capital.
Firm size is expected to have negative impact on cost of equity. Witmer and
Zorn (2007) explain that there tends to be more information available for larger
firms, which can reduces agency costs: when investors have more information
regarding a firm’s management and potential earnings, returns are less uncertain. In
return for this perceived lower risk, shareholders will demand a lower return;
effectively reducing the firm’s cost of equity. In addition, large firms are more
liquid which also decreases the cost of equity.
Beta is expected to be positively correlated with the cost of equity capital.
The Capital Asset Pricing Model indicates that cost of equity capital is increasing in
market beta. Some studies, such as the one of Hail (2002) also confirm this relation
for Switzerland or other countries.
Book – to – market ratio as well as log of B/M is expected to have positive
impact on cost of equity. Fama and French (1992) shows that high B/M firms earn
higher expected return than low B/M. If stocks with high B/M are undervalued,
these stocks should earn abnormally high implied risk premium until the mispricing
is corrected. Stattman (1980) and Rosenberg et al. (1985) also find that average
stock returns are positively related to B/M and log of B/M.
Finally, the association between information asymmetry and cost of equity
remain controversy in numerous studies throughout the world as summarized in
detail in the second chapter. Therefore, the researcher expects there is significant
association between proxies for information asymmetry and cost of equity capital,
but the sign of this relation still should not be determined.
 44

CHAPTER 4: EMPIRICAL RESULTS AND DISCUSSION

4.1. Data statistical description
By using Gretl software, this research obtains the following summary
statistics:
Table 4-1 Data statistical description

Standard
N Mean Median Minimum Maximum
deviation
Variables

COC 222 0.09732 0.09712 0.0006927 0.36223 0.062321

DASC 222 0.050698 0.045702 0.018046 0.12542 0.019018

ABS_DACC 222 0.25956 0.09186 0.000118 6.0465 0.59177

RSD 222 0.02601 0.025423 0.000855 0.05105 0.0070853

SIZE 222 27.774 27.645 25.569 31.959 1.1883

BETA 222 0.6146 0.51907 -0.67337 2.2787 0.51283

BM 222 1.0041 0.79682 0.23749 5.3134 0.76275

LBM 222 -0.18403 -0.22712 -1.4376 1.8427 0.58263

Source: Self-calculation with the support of Gretl software

It can be seen from the table above that, mean (median) of estimated cost of
equity capital (COC) at the end of the first quarter of 2014 in this sample is about
9.73% (9.71%), which is quite higher compared with the estimated cost of equity in
other countries such as Indonesia ( about 7.23% according to Nuryaman (2014)).
This result is also consistent with the real figures in the report of Deutsche Bank
about cost of equity in Asia (January, 2009) which shows that Vietnam’s cost of
equity is one of the highest figures among Asian countries because of its
inefficiency and imbalance in financial sectors.
 45

Regarding to the proxies for information asymmetry, they include adverse

selection transaction cost (DASC), absolute value of discretionary accruals or a
proxy for earning management (ABS_DACC) and residual volatility (RSD). It is
notable that the average adverse selection transaction cost (DASC) in this sample is
0.050698 or about 5.07% which implies that when investors trades on the
Vietnamese stock market, they have to bear the adverse selection cost of about
5.07% of stock price. This result is much higher compared with the average cost of
adverse selection in NYSE (e.g. 0.3% in Ness et al (2001), 3.6% in Glosten and
Harris (1988), or 4.1% in Madhavan et al. (1997)). The mean (median) of
ABS_DACC is about 0.26 (0.092) which demonstrates the higher level of earning
management than the result of Frieldlan (1994) (approximately 16 % before IPO)
and the average discretionary accruals of Indonesia stock exchange in Nuryaman
(2014) (about 8%). The residual volatility in this sample has the mean of 0.026 and
median of 0.0254, which is also a little bit higher than the result of Krishnaswami
et al. (1999) which show the average level of residual volatility of about 2.23% after
spin-off. Therefore, based on the statistical description of three proxies for
information asymmetry, it is apparent that the level of information asymmetry in the
Vietnamese stock market is quite high, especially compared with the prior studies
over the world.
Turning to the group of control variables (BETA, SIZE, LBM), it can be
seen that mean (median) BETA for this sample is approximately 0.6146 (0.519)
which implies that the stock in this sample will be less volatile than the market.
Mean SIZE is 27.774 and the median is quite similar at 27.645, which demonstrates
that the natural log transformation of the total asset can reduce the skewness of
distribution. Mean (median) book-to-market (BM) equals 1.0041 (0.7968). This
indicates that firms trading at a slightly below book value or their undervalued
stocks characterize this sample. Log of book-to-market (LBM) has mean (median)
is -0.18403 (-0.22712) which proves the advantage of using LBM to mitigate the
skewness in the distribution of book-to-market.
 46

4.2. Regression results

4.2.1. Regression of implied cost of equity on control variables and adverse

selection cost
Regression model of implied cost of equity on control variables and adverse
selection cost is illustrated as follows:
Model 1: 𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝐷𝐴𝑆𝐶𝑖 + 𝑈𝑖
Table 4-2 Regression result of Model 1

Model 1: OLS, using observations 1-222

Dependent variable: COC
coefficient std. error t-ratio p-value
const 0. 69247 0.101085 4.6421 <0.00001 ***
S ZE -0.0239829 0.00810984 -2.9573 0.00345 ***
BETA -0.0112052 0.00365284 -3.0675 0.00243 ***
LBM 0.0340685 0.00729741 4.6686 <0.00001 ***
DASC -0.783171 0.218258 -3.5883 0.00041 ***

Mean dependent var 0.097320 S.D. dependent var 0.062321

Sum squared resid 0.633862 S.E. of regression 0.054047
R-squared 0.261528 Adjusted R-squared 0.247916

Source: Self-calculation with the support of Gretl software

Based on the regression results, the regression model can be rewritten as
follow:
𝐶𝑂𝐶𝑖 = 0.469247 − 0.0239829 𝑆𝐼𝑍𝐸𝑖 − 0.0112052 𝐵𝐸𝑇𝐴𝑖 + 0.0340685 𝐿𝐵𝑀𝑖
− 0.783171𝐷𝐴𝑆𝐶𝑖 + 𝑒𝑖
As can be seen from the result table, all the coefficients of independent
variables are statistically significant at the 1% level (SIZE, LBM) because p-value
are smaller than 0.01, which demonstrates the strong association between
independent variables with cost of equity. More importantly, the significant level of
the t-ratio of DASC is smaller than 0.1%, hence, there is overwhelmingly strong
evidence that adverse selection cost has a true non-zero effect in the model.
 47

Regarding to the signs of the associations, the coefficients of two variables

SIZE and LBM confirm the expectations and the prior theories (firm size is
negatively related to the cost of equity and book-to-market ratio has positive impact
on cost of equity). Besides, the negative coefficient of BETA is not consistent with
the expected result or other prior researches (Botosan, 1997; Botosan and Plumlee,
2001; Leuz and Hail, 2006) but can be in line with some studies such as Gebhardt
et al. (2001) who fail to consistently show the expected relationship of beta and cost
of equity.
Moreover, the estimated coefficient of adverse selection cost (DASC) is
negative (-0.783171) which implies the strong negative relationship between
adverse selection cost and cost of equity. In other words, this regression result has
demonstrated the significant association between adverse selection cost as a proxy
for information asymmetry and cost of equity after controlling for market beta, firm
size and book-to-market.
Additionally, the coefficient of determination indicating goodness-of-fit of
the model, R2 is 0.261528 and adjusted R2 is 0.247916 which shows that all the
independent variables explain nearly 24.8% the variation of COC or the cost of
equity capital. This also means that significant variation in the cost of equity capital
still remains to be explained otherwise.

4.2.2. Regression of implied cost of equity on control variables and earnings

management measures
Regression model of implied cost of equity on control variables and earnings
management measures is illustrated as follows:
Model 2: 𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝐴𝐵𝑆_𝐷𝐴𝐶𝐶𝑖 + 𝑈𝑖
 48

Table 4-3 Regression result of Model 2

Model 2: OLS, using observations 1-222

Dependent variable: COC
coefficient std. error t-ratio p-value
const 0.412628 0.10141 4.0689 0.00007 ***
SIZE -0.0181828 0.00821295 -2.2139 0.02788 **
BETA -0.0105288 0.0037135 -2.8353 0.00501 ***
LBM 0.0445737 0.00676586 6.5880 <0.00001 ***
ABS_DACC -0.0134979 0.00629077 -2.1457 0.03301 **

Mean dependent var 0.097320 S.D. dependent var 0.062321

Sum squared resid 0.657523 S.E. of regression 0.055046
R-squared 0.233963 Adjusted R-squared 0.219842

Source: Self-calculation with the support of Gretl software

Based on the regression results, the regression model can be written as
follows:
𝐶𝑂𝐶𝑖 = 0.412628 − 0.0181828 𝑆𝐼𝑍𝐸𝑖 − 0.0105288 𝐵𝐸𝑇𝐴𝑖 + 0.0445737 𝐿𝐵𝑀𝑖
− 0.0134979 𝐴𝐵𝑆_𝐷𝐴𝐶𝐶𝑖 + 𝑒𝑖
It can be noted from the result table that similarly to the regression result of
the model with adverse selection cost, the association between cost of equity capital
and control variables is highly significant in Model 2. To be more specific, the
negative coefficient of book – to - market (LBM) and beta (BETA) statistically
significant at 1% level while the positive coefficient of firm size (SIZE) is
statistically significant at 5% level. Unfortunately, the sign of coefficient of beta is
also conflict with the theory. Furthermore, the negative association between the
absolute value of discretionary accruals as a measure for earnings management and
the cost of equity is weaker compared with that of adverse selection cost with the
coefficient of -0.0134979 and the significant level of 5% (because p-value is
0.03301).
Besides, the value of adjusted R2 is a little bit lower, at 0.219842 which
means that all the independent variables explain nearly 22% the variation of COC or
 49

the cost of equity capital. This result also implies that the variation of cost of equity
need to be explained more by other predictors.

4.2.3. Regression of implied cost of equity on control variables and residual

volatility
Regression model of implied cost of equity on control variables and residual
volatility is illustrated as follows:
Model 3: 𝐶𝑂𝐶𝑖 = 𝛽0 + 𝛽1 𝑆𝐼𝑍𝐸𝑖 + 𝛽2 𝐵𝐸𝑇𝐴𝑖 + 𝛽3 𝐿𝐵𝑀𝑖 + 𝛽4 𝑅𝑆𝐷𝑖 + 𝑈𝑖
Table 4-4 Regression result of Model 3

Model 3: OLS, using observations 1-222

Dependent variable: COC
coeffi ient std. error t-ratio p-value
const 0.511355 0.109486 4.6705 <0.00001 ***
SIZE -0. 215332 0.00817368 -2.6345 0.00903 ***
BETA -0.0127802 0.00382332 -3.3427 0.00098 ***
LBM 0.0399416 0.00702718 5.6839 <0.00001 ***
RSD -1.47997 0.592 -2.4999 0.01316 **

Mean dependent var 0.097320 S.D. dependent var 0.062321

Sum squared resid 0.652676 S.E. of regression 0.054843
R-squared 0.239610 Adjusted R-squared 0.225594

Source: Self-calculation with the support of Gretl software

Based on the regression results, the regression model can be written as
follows:
𝐶𝑂𝐶𝑖 = 0.511355 − 0.0215332 𝑆𝐼𝑍𝐸𝑖 − 0.0127802 𝐵𝐸𝑇𝐴𝑖 + 0.0399416 𝐿𝐵𝑀𝑖
− 1.47997 𝑅𝑆𝐷𝑖 + 𝑒𝑖
It is notable that all the coefficients of control variables are highly significant
at 1% level (p-value <0.01), which demonstrates their true non-zero effects on the
model. The signs of these variables are identical to the results of Model 1 and 2, for
instance, the negative coefficient of firm size, beta and residual volatility; the
positive coefficient of book to price.
 50

Another different point to note in this model is that the negative association
of residual volatility on the cost of equity is much stronger (1 percentage unit
increase in RSD leads to 1.47997 percentage unit less in COC if other factors
remain unchanged) and the adjusted R2 is fairly the same as that of Model 2, at
roughly 22.56%.

4.2.4. Summary
In general, all of the three models have demonstrated the statistically
significant effect of explanatory variables on the dependant variable (cost of equity)
and proved that the negative association between the proxies for information
asymmetry (adverse selection cost, earnings management and residual volatility)
and cost of equity after controlling the effects of firm size, beta and book-to-market
in this sample is highly statistically significant. Regarding to the cross sectional
relationship between control variables and cost of equity, while firm size and book-
to-market confirm the expected signs stated in the previous part, the negative
coefficient of beta is not consistent with many prior theories and research which can
be related to the findings of Gebhardt et al. (2001) which fails to consistently show
the positive relationship of beta and cost of equity. Finally, the indicator of
goodness-of-fit of the regression model, R2 or adjusted R2 is not high (maximum of
about 26.2 % in model 1 with adverse selection cost as a proxy for information
asymmetry) which means that the variation of cost of equity need to be explained
more. However, regardless of the quite low R-squared, the significant coefficients
still draw important conclusions about how changes in the information asymmetry
are associated with changes in the cost of equity in the Vietnamese stock market
which has remained controversy during many years throughout the world.

4.3. Assumption tests

In this part, the researcher will detect problems in regression model by
testing the important OLS assumptions to prove the efficiency and unbiased
characteristics of this empirical conclusion. Because the sample data is cross-
section, this research only tests for multicollinearity and heteroscedasticity in three
models (not autocorrelation test).
 51

4.3.1. Multicollinearity test

Multicollinearity occurs when two or more predictors in the model are
correlated and provide redundant information about the response. In this situation,
the coefficient estimates of the multiple regressions may change erratically in
response to small changes in the model or the data.
First, multicollinearity can be detected by using a correlation matrix or pair
correlation between independent variables –the simplest method. By using Grelt,
this research obtains the following result:
Table 4-5 Correlation matrix of variables

SIZE BETA LBM DASC ABS_DACC RSD

SIZE 1.0000
BETA 0.4497 1.0000

LBM 0.3113 0.0127 1.0000

DASC -0.2633 -0.178 -0.4473 1.0000
ABS_DACC 0.0155 0.0956 -0.0317 0.0698 1.0000
RSD -0.3971 -0.2090 -0.3630 0.7488 0.0877 1.0000

Source: Self-calculation with the support of Gretl software

As can be seen from the correlation matrix, all the correlations between each
pair of six variables have the small absolute values which are smaller than 0.5,
except for the strong positive correlation between residual volatility and adverse
selection cost. Nevertheless, this strong correlation is reasonable because RSD and
DASC are both proxies of information asymmetry and they do not exist in the same
model, hence, their correlation does not have any effect on each model. As a result,
it cannot be concluded that dependant variables in each model are strongly
associated with each other. However, it also cannot be concluded that
multicollinearity does not appear by only using this simple method. Therefore, the
researcher will employ another method to detect multicollinearity which is using
Variance Inflation Factors (VIF).
The variance inflation factor (VIF) quantifies the severity of multicollinearity in
an ordinary least squares regression analysis. It provides an index that measures
 52

how much the variance of an estimated regression coefficient is increased because

of collinearity. VIF can be calculated as follows:
1
𝑉𝐼𝐹𝑖 =
1 − 𝑅𝑖2
where Ri is the multiple correlation coefficient between variable i and the other
independent variables. By using Gretl, this research will obtain VIF value for four
independent variables in each model as follows:
Table 4-6 VIF of three models

VIF
Model 1 Model 2 Model 3
Variable
SIZE 1.425 1.420 1.517

BETA 1.309 1.294 1.291

LBM 1.368 1.133 1.232

DASC 1.304

ABS_DACC 1.011

RSD 1.293

Source: Self-calculation with the support of Gretl software

The table shows that VIF of three models is smaller than 10 and just over 1.
Therefore, it can be proved that the model does not face the problem of
multicollinearity.

4.3.2. Heteroscedasticity test

Heteroscedasticity is a violation of OLS assumption that assume the error
term has a normal distribution with mean zero and constant variance of 𝜎 2 or
Var(Ui) = 𝜎 2 (called homoscedasticity). In other words, if the error terms do not
have constant variance, or 𝑉𝑎𝑟(𝑈𝑖 ) = 𝜎𝑖2 , it can be named as heteroscedasticity.
To detect heteroscedasticity, there are a several methods such as using Park
test (1966), Breusch–Pagan test, White test, Goldfeld–Quandt test… This research
will use White’s test to examine whether the variance of the errors in a regression
 53

model is constant or homoscedasticity. In this test, the Lagrange multiplier (LM)

test statistic which is the product of the R2 value and sample size: 𝐿𝑀 = 𝑛𝑅2 is used
in order to test the null hypothesis H0: no heteroscedasticity or 𝐻𝑜 : 𝜎𝑖2 = 𝜎 2 for all i.
By using Gretl software, this research will get the result of White’s test in the
following table:
Table 4-7 White’s test results of three models

LM Prob (Chi-square(df))>LM

Model 1 17.549688 0.228066

Model 2 54.127194 0.000001

Model 3 18.608692 0.180447

Source: Self-calculation with the support of Gretl software

As can be seen from the table, in Model 1 and Model 3, p-value is larger than
0.05, leading us to conclude that we do not reject the null hypothesis test. In other
word, there is no heteroscedasticity in these two models. However, the p-value for
Model 2 is too small; hence, we can reject the null hypothesis or conclude that there
is heterocedasticity in this model. In spite of this, this research will still retain the
OLS model 2 because the estimators are still linear and unbiased and it will not
have large impact on the conclusion of the association between information
asymmetry and the cost of equity.
 54

CHAPTER 5: CONCLUSION AND RECOMMENDATIONS

5.1. Conclusion
Whether information asymmetry or information quality can have significant
effects on the cost of equity capital is an important and controversial question for
managers, investors, financial institutions and standard setters throughout the world.
By investigating this cross-sectional relation, both individuals and organizations in
business environment can obtain the crucial implications for their investing
decisions or management choices. However, while several theoretical and empirical
researches suggest that increased information asymmetry can raise cost of equity
capital, some studies cannot reach the consensus and give the contradictory
conclusions. Furthermore, in Vietnam, there is still a lack of official and systematic
studies investigating the relation between information asymmetry and cost of equity
capital in the Vietnamese stock market. Therefore, it is inevitable that by examining
the link between information asymmetry and cost of equity of listed companies on
the Vietnamese stock market, this research will make a substantial contribution to
the body of research analyzing the link between asset pricing theory and market
microstructure in Vietnam. It also provides more empirical evidences and references
for other scholars to study more about this crucial academic field. More
importantly, this research will make profound implications for investors, financial
institutions and financial regulatory authorities like State Securities Commission of
Vietnam about the importance of information, disclosure and its effects on the
allocation of capital. These recommendations will be analyzed in detail in the next
part (5.2).
Regarding to the practical results, some notable points of this empirical study
can be summarized as follows. Because the scope of this research is concentrating
on the Ho Chi Minh Stock Exchange (HOSE), after excluding a number of
companies which can not satisfy some specific criteria such as providing financial
reports consistently and sufficiently from 2010 to 2013, or having the different
operation business like financial services companies…, the sample consists of 222
non-financial companies. Furthermore, due to the lack of developed financial
services like analyst’s earnings forecast or shortage of financial information over
 55

the long period because Vietnam stock market is still young and developing, this
research have employed three separate proxies for information asymmetry. They are
adverse selection cost (measured by using Glosten and Harris (1988) model),
earnings management measure (computed by using Friedlan (1994) model) and
residual volatility. The statistical descriptions of these proxies prove that the
estimated degree of asymmetric information in the Vietnamese stock market is
fairly high, compared with other countries’ researches. This result is also in line
with the real situation of information asymmetry in Vietnam where exists a number
of serious examples of insider trading, stock manipulation, spreading misleading
information and rumors like the cases of DVD, SBS… In addition, this study also
applies Residual Income Valuation Model (RIM) to estimate the implied cost of
equity that is demonstrated to be useful in investigating the link between
information and cost of equity by prior researches. Following many related studies
like Botosan (1997), Botosan & Plumlee (2002), Hail (2002), Leuz & Hail (2006),
Botosan & Plumlee (2013).., the researcher have run the regression of cost of equity
on each proxy for information asymmetry and three control variables which are firm
size, market beta and book-to-market ratio. After using OLS regression and testing
for assumptions, this research can obtain the result that all of the independent
variables have statistically significant effects on the cost of equity in three models.
However, while the signs of firm size and book-to-market confirm the expectation
and prior theory (the negative effect of firm size and positive effect of book-to-
market on the cost of equity), the market beta has unexpected sign of association, or
negatively related to cost of equity. More importantly, this research also reaches the
important conclusion that there is a significantly negative association between
information asymmetry and cost of equity of companies listed on Vietnam stock
market in this sample. In fact, this result is not consistent with many past findings
or theoretical literature over the world like Easley and O’Hara (2004), Leuz and
Verrecchia (2004), Petrova et al. (2012)… However, it can be explained by other
researches as well as by combining with the real situation in the Vietnam stock
market. In other words, there are two main contributing factors to this negative
association:
 56

- Firstly, according to Lambert, Leuz, and Verrecchia (2006), increasing the

degree of information asymmetry between investors can reduce the cost of capital,
provided that the average precision increases. In other word, they demonstrate that
information asymmetry and information precision have separate and different
effects on cost of equity. Another evidence for this finding is that when the
Securities and Exchange Commission (SEC) enacted Regulation Fair Disclosure
(Reg FD) which intends to equalize information across investors, SEC
Commissioner Unger (2000) voted against this regulation because of concerns that
it would most likely reduce the amount of information available to investors and the
quality of the information, and even increase cost of equity in small firms as
empirical evidence in Gomes et al. (2006). Applying this theory into the
Vietnamese stock market, we cannot turn a blind eye to the fact that due to the low
level of quality, transparency and precision of information disclosed from the listed
companies, disclosure policies of these companies to reduce information asymmetry
can have opposite effect on uninformed investors. In other words, the dissemination
of low quality or unclear information from companies can increase the uncertainty
of uninformed investors, which leads to their demand for return risk premium or
raise cost of equity. Therefore, one of the important reasons for the negative link
between information asymmetry and cost of capital in this finding is the low quality
and lack of transparency of information disclosure in the Vietnamese stock
market. This serious issue can bring about detrimental effects on the endeavors to
mitigate information asymmetry and develop information environment in the
Vietnamese stock market.
- Another root cause of this finding lies in the capability and knowledge of
investors in Vietnam stock market. Botosan and Plumlee (2002), Bushee and Noe
(2000) show empirical evidences that more timely disclosure can raise cost of
equity by attracting transient investors, which exacerbates a firm’s stock return
volatility with their short investment horizons and aggressive trading strategies. In
addition, all else being equal, an increase in volatility leads investors to demand
higher returns from their shares as compensation for the added risk and from the
perspective of the corporation, this translates into a higher cost of capital. Regarding
 57

to the real situation in the Vietnamese stock market, it is evident that a large number
of investors in Vietnam are lack of necessary knowledge about investment as well
as sufficient experiences, often trade or buy share based on their personal emotions,
rumours or highly affected by herd behaviours… As a result, their reactions to any
disclosed information can be too much aggressive which can often lead to the sharp
volatility in stock price, and then raising the cost of equity.

5.2. Recommendations
Based on the empirical result of the negative association between
information asymmetry and cost of equity in Vietnam, as well as taking into
account both of two reasons for this relation, this research will make some
recommendations for investors, managers of listed companies as well as financial
institutions and regulatory authorities. More particularly, to achieve both the goals
of reducing information asymmetry and lowering cost of capital, in turn improving
investment environment and enhancing the efficiency of financial market and
allocation of capital, all participants in financial markets should focus on enhancing
the quality and transparency of information disclosure as well as improving the
capability and competency of investors in the Vietnamese stock market. In other
words, the disclosure policies or disseminating information systems of listed
companies, regulatory bodies and other financial systems in Vietnam will be
effective and useful provided that these conditions of the quality of disclosed
information and the capacity of investors are guaranteed.

5.2.1. Recommendations to investors

Currently, a large number of the Vietnamese investors have been amateur
investors, inexperienced and lack of necessary financial knowledge. In order to
avoid the information risk as well as to be capable of making the right investment
decisions, the investors should place more emphasis on improving their capacity
and investment knowledge to actively access adequate information and analyze it
efficiently by taking some urgent and feasible actions:
- They should improve their investment knowledge by taking some courses
relating to the fundamental of stock market, financial reporting and analyzing
securities. In light of this, they can improve the ability of seeking, selecting and
 58

screening relevant and useful information that will play a vital role in their process
of making the right investment decisions.
- Furthermore, they also should keep up-to-date with the current affairs on
financial market in Vietnam and over the world through many mass media channels
like newspapers, internet, annual reports… and actively participate in road show
events or annual meeting of shareholders where they can express their opinions and
exercise their voting rights.
- Besides, they should keep cautious and remain skeptical on the questionable
and unofficial sources of information as well as the rumors to protect them from
herd effects or stock manipulation behaviors.

5.2.2. Recommendations to listed companies

With the long-term purpose of maximizing the shareholder’s value and
reducing cost of capital, this research suggests that public companies should place
more emphasis on the importance of information disclosure as well as increasing
the quality of disclosed information. To achieve this goal, the management of listed
companies should take effective steps to ensure the process of providing sufficient
and adequate information periodically, timely and on demand, according to the
Circular No.52/2012/TT-BTC about the disclosure of information on securities
market. They should establish a separate department specializing in disclosing
information and being responsible for the quality of disclosed information and
avoiding inaccuracy and flaws of information. Moreover, to improve the
transparency of public information, they also should pay more attention to the
operation of internal controls and develop the independent and competent internal
audit committee. Last but not least, public companies should focus more on the
efficiency of investor relation by setting up the website with complete and updated
information about the company, organizing the annual meetings of shareholders…
in order to build up the long-lasting relationships with shareholders and minimizing
conflicts of interest between related parties.
 59

5.2.3. Recommendations to securities companies

In 2013, a large number of securities companies were under bankruptcy
pressure. To be more specific, the State Securities Commission of Vietnam has
classified securities companies into four groups of securities companies. As many
as 79 companies had healthy operations, eight companies had normal operation, five
companies were put under control and nine companies were under special control.
Actually, at the end of 2013, 15 securities companies closed their operations. This
restructuring process has posed a challenge to securities companies; hence, to exist
and improve their business performance, financial companies also should take care
of the transparency and disclosing high-quality information by adopting some
measures. Firstly, they should establish and follow the principles of information
disclosure, recruiting the employees with sufficient knowledge, responsibilities and
professional ethics to obtain investors’ trust as well as support investors in making
their right investment decisions. Secondly, it is crucial for securities companies to
invest and develop cutting-edge IT system and synchronized infrastructure to ensure
the efficiency of disseminating financial information. Moreover, there should be
segregation duties between brokerage department and investment division inside the
securities companies to avoid stock manipulation as well as defend investors.

5.2.4. Recommendations to financial regulatory authorities

 According to Mr. Dinh Tien Dung, Minister of Finance, one of the five goals
that Vietnamese stock market will have to achieve in 2014 is enhancing the
transparency of information of listed companies on the Vietnamese stock market.
To accomplish this goal, recently the Ministry of Finance has issued many legal
documents on information disclosure such as Circular No.52/2012/TT-BTC dated
April 05, 2012 guiding the disclosure of information on securities market; Circular
No.13/2013/TT-BTC dated January 25, 2013 on supervision of securities
transactions on the securities market… Furthermore, in 2013 and 2014, Hanoi Stock
Exchange (HNX) has enacted the program of “Evaluating the information
disclosure and transparency” for all listed companies on HNX. In terms of
assessment methodology, the HNX used OECD recommendations on corporate
governance to draw up the five criteria, including the rights of shareholders, equal
 60

treatment for shareholders, the roles stakeholders play, the disclosure of transparent
information and the responsibilities shouldered by managing boards. Out of these
five, the disclosure of transparent information recorded the highest average score. In
light of these active policies and measures, the level of transparency in the stock
market has gradually improved to help regain investor’s trust in 2013, as said
Mr. Vu Bang, President of the State Securities Commission. However, to enhance
the quality of disclosed information more considerably and ensure the efficiency of
the disclosure policies, the financial regulatory authorities should take further steps
that are suggested as follows:
- The State should open the door to establish and develop the models of
companies specializing in seeking, screening and analyzing information like
Thompson Reuters, Bloomberg … in Britain and American market. Accompanied
with this measure, the State should set up a mechanism of supervising these
companies to avoid frauds in providing information.
- Furthermore, the State should set out the stricter regulations on information
disclosure systems of public companies, especially the content of the official
websites of the listed companies. In fact, there are many companies which have not
focused on developing their websites, even presented poor and out-of-date content
on their websites. Besides, the State Securities Commissions should modernize the
means of information disclosure and motivate other agencies to diversify methods
of information disclosure on securities exchanges with the purpose of making
sufficient information available to all participants on stock market.
- Last but not least, the State should impose heavier sanctions against
violations of information disclosure on stock market. Recently, the Government has
issued Decree 108/2013/ND-CP providing sanctions against administrative
infringes in securities operations and transactions on the stock market. The Decree
has raised the fines for some violations that can severely affect the rights and
interests of investors, the fairness, transparency and stable operation of the stock
market to the maximum of 2 billion VND for violating organizations and 1 billion
VND for individuals. According to Vu Thi Chan Phuong, Head of the Inspection
Department of the State Securities Commission, this decree is extremely important
 61

to the stock market as it creates an open and transparent environment to protect

investors. However, it is predicted that breaches or violations on the stock market
will become more complicated, especially violations of information disclosure and
reporting of market participants. As a result, the agencies and authorities should
continue to take feasible measures to manage, prevent and handle violations.
 Additionally, in order to increase the efficiency of these transparency
motivation measures, the financial authorities should also take active actions to
improve the average investment knowledge and skills of Vietnamese investors:
- The State should implement and carry out more education and training
programs about basic knowledge of stock market for the entire Vietnamese people
on the mass media or through practical courses. Simultaneously, the financial or
economic news and programs on televisions, radios… should be upgraded in terms
of both quality and quantity to offer the most useful financial lessons to all
investors.
- Moreover, the State should allocate more funding to support the research
programs about the development of the stock market, in turn, enhancing the quality
of human resource for financial and securities sector. At the same time, the State
should take advantage of the support from international organizations and send the
young researchers to developed countries to learn from experiences of these
developed financial markets and apply in to the situation of Vietnam. As a result,
the improvement in the competency and capabilities of the professionals and
officers working in the financial authorities or universities will play a crucial role in
boosting the average abilities and knowledge of investors.

5.3. Limitations of the study

Apart from some important empirical evidences and contributions that this
research has demonstrated, there are also some inevitable limitations in this study:
- In terms of data, the sample of this study consists of only listed companies on
HOSE, not both of two exchanges. As a consequence, this finding cannot reflect
totally the situation of the Vietnamese stock market as well as may not be
applicable for global application. Besides, the period the researcher investigates is
short, only one-year period of 2013, which can lead to some shortcomings in the
 62

results compared with other studies examining over long horizon. In other words, to
reach more accurate results, the researcher should expand the sample as well as the
scope of time.
- Regarding to the methods employed to measure information asymmetry and
cost of equity capital, due to the short history of Vietnamese stock market as well as
a lack of the long-term and sufficient data, this research has not employed some
proxies or measurement methods such as abnormal return proxy, analysts’ earnings
forecasts for asymmetric information, or time-series models to measure earning
management, adverse selection cost and the implied cost of equity. As a result,
compared with other researches like Botosan and Plumlee (2002), Easley et al.
(2002)… the result of this research can reflect less reliability of the testing model.
- Another limitation of this research lies in the reasons for this negative
association which require more further investigation relating to the information
structure (as in research of Easley and O’Hara (2004)) or average precision of
information (as in research of Lambert, Leuz, and Verrecchia (2006)). In other
words, the result of this research is only limited to empirical evidence of the link
between information asymmetry and cost of equity, but not prove the reasons for
this association.

5.4. Suggestions for future study

The findings about the negative link between information asymmetry and
cost of equity in Vietnam stock market raise a number of issues for further study.
First of all, the researcher should extend the sample and test period to investigate
all companies listed on Vietnam stock market during the long period to examine
the result. Secondly, this research should use more proxies for information
asymmetry as well as apply another methods to estimate cost of equity to give the
most unbiased and sufficient empirical evidences. Furthermore, as this analysis
suggest that the reasons for this association may lie in the quality of information
disclosure and the capability of investors, in the future studies, the researcher
should examine the effects of the factors like private information or average
precision of information on the cost of equity as well as on the link between
information asymmetry and cost of equity. Finally, this results also raise
 63

interesting questions about security market design and the cost of capital. In
particular, how transparency of trades and orders influence the informativeness of
stock prices, or even how the speed of the trading system affects information flows
to investors, seem important directions for future research. In other words, future
research should examine other variables relating to information like disclosure
policies, the speed of information trading system in relation to the cost of equity
capital.
 64

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 68

APPENDIX 1
Calculation of the implied cost of equity capital for
Dong Phu Rubber Joint Stock Company (DPR)
This research will estimate the implied cost of equity capital of DPR at the
end of the first quarter of 2014 by using RIM model. Data of book value, dividend,
EPS… are collected from annual financial statements of DPR during the 4-year
period from 2010 to 2013. Earnings are forecasted by estimating the expected
growth rate (g). The expected dividend payout ratio and expected ROE are
estimated by computing the average value of previous years.
Firstly, the expected growth rate is estimated in the following table:
Table A-1: Estimating the expected growth rate of DPR

Year Unit 2010 2011 2012 2013 Average

(1) Book value per share

VND 28,543 44,421 50,697 53,456
(Bt)

(2) Earnings per share

VND 9,165 18,663 12,552 8,580
(EPSt)

(3) Dividend per share

VND 3,000 5,000 4,000 3,000
(DPSt)
(4) Return on equity (ROEt)
% 32.11 42.01 24.76 16.05 28.73
= (2)/(1)

(5) Dividend payout ratio

% 32.73 26.79 31.87 34.96 31.59
(δ) = (3)/(2)
(6) Expected growth rate
% 19.66
= Average(4)* (1-Average(5))

Source: Annual reports of DPR in 2010-2013 and self-calculation

Next, using the expected growth rate g (19.66%) and the expected dividend
payout ratio δ (31.59%), the expected earnings in 2014 and 2015 and the book value
per share in 2014 are estimated as follows:
 69

EPS2014 = EPS2013*(1+g) = 10,267 (VND)

EPS2015 = EPS2014*(1+g) = 12,285 (VND)

𝐵2014 = 𝐵2013 + 𝐸𝑃𝑆2014 (1 − 𝛿 ) = 60,479 (VND)

Finally, after collecting the stock price of DPR at the end of the first quarter
of 2014 from website http://www.ftps.com.vn (Pt = 44,200 VND), the researcher
will solve the following quadratic equation to find out the implied cost of equity of
DPR (re):
𝑃𝑡 𝑟𝑒2 + (𝑃𝑡 − 𝐸𝑃𝑆2014 + 𝐵2014 − 𝐵2013 )𝑟𝑒 − 𝐸𝑃𝑆2015 = 0
or
44,200 𝑟𝑒2 + 40,956.9 𝑟𝑒 − 12,285 = 0

Solving the above equation the researcher will find the positive root is
equal to 0.2385 or 𝑟𝑒 = 23.85% . In other words, the estimated implied cost of
equity of DPR at the end of the first quarter of 2014 is 23.85%
 70

APPENDIX 2
Calculation of the adverse selection cost of transacting for DPR
To calculate the adverse selection cost of transacting for DPR, this research
will use Glosten and Hariss (1988) model as follows:
𝑃𝑡 − 𝑃𝑡−1 = 𝑐0 (𝑄𝑡 − 𝑄𝑡−1 ) + 𝑐1 (𝑄𝑡 𝑉𝑡 − 𝑄𝑡−1 𝑉𝑡−1 ) + 𝑧0 𝑄𝑡 + 𝑧1 𝑄𝑡 𝑉𝑡 + 𝜀𝑡
Where:
Pt and Pt-1 is the observed transaction price at time t and t-1;
Vt and Vt-1 is the volume or the number of shares traded in the transaction at
time t and t-1;
c0, c1, z0, z1 are the coefficients of the model and 𝜀𝑡 ;
Qt is +1 if at transaction time t we have Pt > Pt-1;
Qt is - 1 if at transaction time t we have Pt < Pt-1;
Qt is equal to Qt-1 if at transaction time t we have Pt =Pt-1.
After collecting the daily closing price (Pt) and the transaction volume (Vt)
for DPR during the test period (from 1/1/2013 to 31/12/2013), the researcher will
run OLS regression for the above model and obtain the following result:
Table A-2: Regression result of Glosten and Hariss model for DPR

Coefficient Std. Error t-ratio p-value

const -0.014275 0.054706 -0.2609 0.79436
c0 0.253784 0.065348 3.8836 0.00013 ***
c1 -7.99642e-07 1.12216e-06 -0.7126 0.47678
zo 0.512118 0.0896231 5.7141 <0.00001 ***
z1 6.85177e-07 1.34754e-06 0.5085 0.61158
Source: Self-calculation with the support of Gretl software

As can be seen from the table, we have: c0 = 0.253784; c1 = -7.99642e-07;

zo = 0.512118; z1 = 6.85177e-07.
Moreover, based on the daily price and transaction volume, we can calculate
̅𝑃𝑡 = 49.6956; 𝑉̅𝑡 = 33,254.4. Hence, the adverse transaction cost of DPR is
estimated as follows:
𝐷𝐴𝑆𝐶𝐷𝑃𝑅 = 2 (𝑧0 + 𝑧1 𝑉̅𝑡 )⁄𝑃̅𝑡 = 0.021527
Similarly, this research estimates the adverse selection cost of all 222 listed
companies in the sample as in the table A-3.
 71

Table A-3: Adverse selection cost of 222 listed companies in the sample

AAM ABT ACC ACL AGF AGM ANV APC ASM ASP ATA AVF

0.073257 0.030165 0.034158 0.057173 0.034158 0.067142 0.073823 0.041805 0.053096 0.042223 0.074618 0.055208

BBC BCE BCI BHS BMC BMP BRC BSI BT6 BTP BTT C21

0.048314 0.041274 0.035198 0.033103 0.044788 0.036981 0.048988 0.054762 0.063098 0.034962 0.046929 0.035476

C32 CCI CCL CDC CIG CII CLC CLG CLW CMG CMT CMV

0.027087 0.055723 0.059621 0.060912 0.070707 0.039593 0.029814 0.097136 0.052084 0.069428 0.059822 0.06128

CNG CSM CTI CYC D2D DAG DCL DHA DHC DHG DHM DIC

0.027206 0.032113 0.048667 0.072813 0.036246 0.054473 0.03523 0.040101 0.070703 0.026619 0.093661 0.044555

DIG DLG DMC DPM DPR DQC DRC DRH DSN DTL DVP DXG

0.044162 0.063744 0.03048 0.024312 0.021527 0.029387 0.035149 0.086717 0.031536 0.058776 0.05859 0.048177

ELC EMC EVE FCN FDC FMC FPT GAS GDT GIL GMC GMD

0.090761 0.074017 0.045745 0.052161 0.080536 0.039528 0.018046 0.03144 0.045232 0.072192 0.027393 0.040936

GSP GTA GTT HAG HAP HAR HAS HBC HDC HDG HHS HMC

0.031206 0.040028 0.040786 0.043897 0.049334 0.108634 0.070383 0.036516 0.037841 0.039532 0.054553 0.040284

HPG HQC HSG HT1 HTI HTV HU1 HU3 HVG ICF IDI IJC

0.022829 0.053947 0.058776 0.057999 0.031224 0.043001 0.066448 0.0806 0.055157 0.061399 0.043262 0.05243
 72

IMP ITA ITD JVC KBC KDC KHA KHP KMR KSA KSB KSH

0.024973 0.067657 0.057813 0.036617 0.055655 0.024181 0.034039 0.031968 0.058995 0.051892 0.032202 0.084488

KSS KTB L10 LAF LBM LCM LGC LHG LSS MCP MDG MHC

0.070373 0.065391 0.037762 0.044761 0.0368 0.064544 0.092978 0.079936 0.044375 0.059973 0.058772 0.071837

MPC MSN MTG NAV NBB NHS NKG NLG NNC NSC NTL NVT

0.074943 0.04765 0.060255 0.063704 0.071716 0.034286 0.085509 0.075379 0.041819 0.051822 0.040255 0.060201

OPC PAC PDN PET PGC PGD PHR PJT PNJ PPC PPI PTB

0.04445 0.036431 0.023288 0.037215 0.037736 0.029675 0.026892 0.045385 0.026258 0.038788 0.069159 0.03173

PTC PTK PVD PXI PXS QCG RAL RDP REE SAM SAV SBT

0.072979 0.051391 0.029432 0.067194 0.034026 0.053033 0.034782 0.058371 0.027864 0.039992 0.038132 0.035536

SC5 SCD SEC SFI SGT SHI SII SJD SJS SMA SMC SPM

0.03684 0.044565 0.074513 0.028554 0.073549 0.083847 0.031301 0.030885 0.056476 0.053464 0.042055 0.083296

SRC SSC ST8 SVC SVI SVT SZL TAC TBC TCL TCM TCO

0.031569 0.06728 0.040448 0.031136 0.071758 0.125425 0.032652 0.04267 0.036211 0.029215 0.025872 0.084065

TDC TDH THG TIC TIE TIX TLG TLH TMP TMT TNA TNC

0.040154 0.04046 0.058798 0.056546 0.031208 0.054151 0.036892 0.053714 0.05053 0.08736 0.033544 0.03207
 73

TPC TRA TRC TS4 TSC TTF TTP TYA UDC VCF VFG VHC

0.036507 0.04707 0.044398 0.043296 0.048225 0.052669 0.066914 0.044013 0.060971 0.074311 0.06052 0.071818

VHG VIC VID VIP VMD VNE VNH VNM VNS VPH VPK VRC

0.087204 0.035858 0.080585 0.037975 0.061392 0.046671 0.062988 0.024941 0.038622 0.048899 0.04161 0.067172

VSC VSH VSI VTB VTF VTO

0.029434 0.032614 0.124089 0.045193 0.057089 0.045659