Information asymmetry refers to any situation in which information abo

Question

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  
 OA E 
 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  
 OA B 
 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 
 OA E 
 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.

thanhtam0102 · Answer

Question 1: E. They minimize the advantage of privately informed investors trading with other investors.
"Such conference calls can mitigate information asymmetry in several ways."

Question 2:B. The nature of the relationship between conference calls and the attitudes of investors towards the companies that hold them is not definitively understood.
"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."

Question 3: Companies with the least information assymetry problems are the ones with the lowest cost of capital.
This is too strong and is not mentioned in the passage.

subhendu389 · Answer

Can someone explain why 2.D is wrong. Thanks!!

manishpatwal · Answer

Transparency # ethics..

Sent from my ASUS_Z00LD using  GMAT Club Forum mobile app

Wonsuk · Answer

I am not sure with the OA for #3.

E) can be true but we cannot say it must be true

whereas....

B) may not be true as its explicitly mentioned in the passage that "Information asymmetry refers to any situation in which information about the value of a publicly traded company is distributed unevenly among  INVESTORS ." and we are not sure whether the  INVESTMENT ANALYSTS   mentioned in B) are actually the  INVESTORS .

I may not be right but B) sounds much better than E).

ashish8814 · Answer

can nyone explain how ans is b in q2.. in my opinion both b and e are equal competitor. how can v distinguish which one is better. tia

JenniferAtKaplan · Answer

It's great to see so much interest in this passage, and I'm happy to join in and answer some questions!

For Wonsuk's question, yes, answer choice E for #3 is something that could be true but is not necessarily true. The reason E is correct is the presence of the “EXCEPT” in the question stem. This tells us that we are looking for the one choice that we cannot infer from the passage.

For ashish8814's question about #2, the problem with E is that it is too strongly worded. The passage states that conference calls “can mitigate information asymmetry,” but it never goes so far as to state that the conference calls are the “best” way to do so. Answer choices that are strongly worded can only be correct when the passage is equally strongly worded. Answer choice B's wording reflects the lack of certainty mentioned in the third paragraph.

I will also add that manishpatwal is correct in the response given to subhendu389. Answer choice D is incorrect for #2 in part because transparent and ethical have different meanings and are not interchangeable. D is also too strong in stating that these companies “are perceived” when the author states in the passage that these companies “may be perceived.”

Best,
Jennifer Kindy

nitesh50 · Answer

Hi.
I can't understand your point regarding Q3. Option b is something that can also not be directly inferred from the passage. whereas option E could be true. should't we then pick option B instead of OptionE.

JenniferAtKaplan · Answer

Hi, Nitesh. Choice B actually can be inferred from the passage, because an analyst having such information before other investors do is, in fact, an example of a "situation in which information about the value of a publicly traded company is distributed unevenly among investors."

Jennifer

popovarseniy · Answer

I am not definitely sure about 2B as OA. The passage says: "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." So the point is that "may be" doesn't' equal to definitely?

Kunal112 · Answer

I agree on the same. In my opinion, B is an extreme option (which should be avoided) and also leaves no scope for conference calls to even be a minor factor

Also, though E isn't very accurate but is the best option to go for after eliminating the rest

shubham2312 · Answer

if possible someone kindly share how they rejected Option A for Question 3,

because as per the Passage we are given

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.

Although i was able to answer the question correctly because wordings of option E are just too extreme.

OhsostudiousMJ · Answer

Hi,
So, should we just assume that investors = investment analysts? That was the reason why I chose B over E.

NoMatterWhat · Answer

How to Eliminate Option A

Stated in 2nd para
in order to lower their cost of capital, many publicly traded companies are looking for ways to reduce information asymmetry.

It implies Distribution of information affects capital size.

Hope it Helps
Don't worry about KUDOS

GMATINSECT · Answer

What should be the ideal expected time to solve this passage?

I took 5 mins 30 sec. Should it be ideally less than this ??

arvind910619 · Answer

Hi D ethical is not same as transparent. Passage is talking about transparency of information.

Makhabbat · Answer

Hello! Can someone explain 2nd question, I am a bit confused. 
Thank you!

Sajjad1994 · Answer

Explanation

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

Difficulty Level:   Hard

Explanation

It is a global inference question that cannot be answered by reading a specific portion of the passage; instead, it is based on most of the last two paragraphs. Read the answer choices one by one and use POE to reach the answer. I have answered it correctly in 1:23

A. Companies that lack a ready source of capital should hold frequent conference calls to address the problem.

It seems not related to the question, an easy one to eliminate.

B. The nature of the relationship between conference calls and the attitudes of investors towards the companies that hold them is not definitively understood.

It seems a strong one, so let's keep it and continue reading.

C. Conference calls present the disadvantage of alienating investors who would otherwise be the recipients of private information about a company.

It could be a trap, but this is opposed by only the word "disadvantage," hence alienating investors who would otherwise be the recipients of private information is not a disadvantage, according to the passage.

D. Companies that hold frequent conference calls are perceived to be more ethical than companies that do not hold conference calls.

This is another trap this interchanging "Transparency" for "Ethics" both are two different characteristics and cannot use interchangeably.

E. Conference calls are the best way for a company to alleviate the problem of information asymmetry.

This is extreme! Although the passage stated that Conference calls help but it didn't say that it is the  best  way to alleviate the problem of information asymmetry. Do not take anything for granted.

Among all the five options  (B)  is the best.

Answer: B

Tanvay · Answer

D is wrong because it hasn't said anything about the comparison.

Information asymmetry refers to any situation in which information abo

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Information asymmetry refers to any situation in which information abo

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