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Information, Investment Adjustment, and the Cost of Capital

  • Lixin Huang and Qiang Kang

Private information imposes a severe trading disadvantage on uninformed traders while at the same time providing firms with valuable signals for investment adjustment. The two forces have opposite impacts on the cost of capital, and the net effect depends on which force dominates. We show that stocks of firms with low flexibility in investment adjustment (“value firms”) command an information premium, whereas stocks of firms with high flexibility in investment adjustment (“growth firms”) deliver an information discount. These results are consistent with the findings that growth firms exhibit stronger investment sensitivity to information in stock prices than value firms.

Corresponding author
* Huang,, Georgia State University Robinson College of Business; Kang (corresponding author),, Florida International University College of Business.
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We thank an anonymous referee, Rui Albuquerque, Sandro Andrade, Robin Greenwood, Hui Guo, Jarrad Harford (the editor), Christopher Hennessy, Wei Jiang, Yexiao Xu, and seminar participants at Clark University, Federal Reserve Board, Florida International University, Fordham University, George Mason University, Johns Hopkins University, University of Iowa, University of Miami, University of Texas at Dallas, the 2010 All-Georgia Finance Conference at the Federal Reserve Bank of Atlanta, and the 2010 Financial Management Association Annual Meetings for helpful comments and suggestions. We are grateful to Soren Hvidkjaer and Stephen Brown for providing us with their data on the probability of informed trading. All remaining errors are ours.

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Journal of Financial and Quantitative Analysis
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