Information and the Cost of Capital David Easley and Maureen O'Hara Johnson This paper investigates the role of information in affecting a firm’s cost of capital. It focuses on the specific roles played by public and private information. The argument is that differences in the composition of information between public and private information affect the cost of capital, with investors demanding a higher return to hold stocks with greater private, and correspondingly less public, 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. This cross-sectional effect results in the uninformed traders always holding too much of stocks with bad news, and too little of stocks with good news. Holding more stocks cannot remove this risk because the uninformed are always on the wrong side; holding no stocks is sub-optimal because uninformed utility is higher holding some risky assets. Moreover, the standard separation theorem that typically characterizes asset pricing models does not hold here because informed and uninformed investors perceive different risks and returns, and thus hold different portfolios. Private information thus induces a new form of systematic risk, and in equilibrium investors require compensation for this risk. The authors develop their results in a multi-asset rational expectations equilibrium model that includes public and private information, and informed and uninformed investors. Important features of the model are risk averse investors, a positive net supply (on average) of each risky asset, and incomplete markets. They find a partially revealing rational expectations equilibrium in which assets generally command a risk premium. The model demonstrates how in equilibrium the quantity and quality of information affects asset prices, resulting in cross-sectional differences in firms' required returns. What is particularly intriguing about the model is that it demonstrates a role for both public and private information to affect a firm's required return. This provides a rationale for how an individual firm can influence its cost of capital by choosing features like its accounting treatments, financial analyst coverage, and market microstructure. They also show why firms with little available information, such as IPOs, face high costs of capital: in general, more information, even if it is privately held, is better than no information at all. The paper also discusses the effects of information on asset prices and the cost of capital. It shows that the distribution of private information affects the return investors require to hold any stock in equilibrium. A firm whose stock has relatively more private information and less public information thus faces a higher cost of equity capital. The dispersion of private information is captured by the variable μk, the fraction of traders who receive the private information. A higher value of μk means that more traders know the information, and in equilibrium this influences the risk premium of the stock through two channels. First, the stock is less risky for informed traders than it is for uninformed traders. Thus, on average, informed traders hold greater amounts of the stock. So if more traders are informedInformation and the Cost of Capital David Easley and Maureen O'Hara Johnson This paper investigates the role of information in affecting a firm’s cost of capital. It focuses on the specific roles played by public and private information. The argument is that differences in the composition of information between public and private information affect the cost of capital, with investors demanding a higher return to hold stocks with greater private, and correspondingly less public, 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. This cross-sectional effect results in the uninformed traders always holding too much of stocks with bad news, and too little of stocks with good news. Holding more stocks cannot remove this risk because the uninformed are always on the wrong side; holding no stocks is sub-optimal because uninformed utility is higher holding some risky assets. Moreover, the standard separation theorem that typically characterizes asset pricing models does not hold here because informed and uninformed investors perceive different risks and returns, and thus hold different portfolios. Private information thus induces a new form of systematic risk, and in equilibrium investors require compensation for this risk. The authors develop their results in a multi-asset rational expectations equilibrium model that includes public and private information, and informed and uninformed investors. Important features of the model are risk averse investors, a positive net supply (on average) of each risky asset, and incomplete markets. They find a partially revealing rational expectations equilibrium in which assets generally command a risk premium. The model demonstrates how in equilibrium the quantity and quality of information affects asset prices, resulting in cross-sectional differences in firms' required returns. What is particularly intriguing about the model is that it demonstrates a role for both public and private information to affect a firm's required return. This provides a rationale for how an individual firm can influence its cost of capital by choosing features like its accounting treatments, financial analyst coverage, and market microstructure. They also show why firms with little available information, such as IPOs, face high costs of capital: in general, more information, even if it is privately held, is better than no information at all. The paper also discusses the effects of information on asset prices and the cost of capital. It shows that the distribution of private information affects the return investors require to hold any stock in equilibrium. A firm whose stock has relatively more private information and less public information thus faces a higher cost of equity capital. The dispersion of private information is captured by the variable μk, the fraction of traders who receive the private information. A higher value of μk means that more traders know the information, and in equilibrium this influences the risk premium of the stock through two channels. First, the stock is less risky for informed traders than it is for uninformed traders. Thus, on average, informed traders hold greater amounts of the stock. So if more traders are informed