Information asymmetry refers to any situation in which information abo

Information asymmetry refers to any situation in which information about the value of a publicly traded company is distributed unevenly among investors. When some investors obtain private information that is not available to investors in general, they can use that information to trade profitably with uninformed investors. Uninformed investors tend to demand a return premium to compensate them for the risk of trading with privately informed investors, and this risk premium in turn increases the firm's cost of capital.

Therefore, in order to lower their cost of capital, many publicly traded companies are looking for ways to reduce information asymmetry. Some companies have addressed the issue by regularly disseminating material information via conference calls with board members, executives and professional stock analysts. Such conference calls can mitigate information asymmetry in several ways. Frequent conference calls directly increase the amount of information available to investors, and they lower the incentive for private investors to seek out what undisclosed information remains. Furthermore, because information is more readily available to all investors, the potential benefits of trading on private information may be reduced.

In fact, according to research performed by economists Stephen Brown, Stephen Hillegeist and Kin Lo, frequent disclosure of substantial information via conference calls can materially increase the relative amount of trading in a firm's stock by uninformed investors. While it is not certain that conference calls are the sole factor in increasing trading by uninformed investors, companies that hold these calls may be perceived by investors to be more transparent than companies that do not. This, in turn, can reduce the risk borne by investors who lack private information.

1. According to the passage, which of the following is true concerning conference calls?

A. They cause a company to gain more revenue by improving the company's image.
B. They minimize the investment of privately informed investors.
C. They allow stock analysts to ask company executives questions about the financial health of a company.
D. They are the best way for a company to make large sums of capital available in a short time frame.
E. They minimize the advantage of privately informed investors trading with other investors.


2. The author of this passage would be most likely to agree with which of the following statements?

A. Companies that lack a ready source of capital should hold frequent conference calls to address the problem.
B. The nature of the relationship between conference calls and the attitudes of investors towards the companies that hold them is not definitively understood.
C. Conference calls present the disadvantage of alienating investors who would otherwise be the recipients of private information about a company.
D. Companies that hold frequent conference calls are perceived to be more ethical than companies that do not hold conference calls.
E. Conference calls are the best way for a company to alleviate the problem of information asymmetry.

3. Each of the following is an inference that may properly be drawn from the passage EXCEPT:

A. The distribution of information among a company's shareholders can affect the company's ability to raise capital.
B. An investment analyst obtaining a copy of a company's financial statements before the statements are filled with regulatory authorities could be an example of information asymmetry.
C. Investors who are aware of a decline in a company's sales may be able to profit by selling their shares in the firm to uninformed investors.
D. Some investors who demand a return premium when investing in a company know of information asymmetry among that company's investors.
E. Companies with the least information assymetry prblems are the ones with the lowest cost of capital.