Managers and major shareholders typically have an information advantage over outside investors when trading a company’s shares. Numerous studies have been done into the relation between ownership concentration, industry competition and information asymmetry, but rarely using Australian data. The output of this study is particularly relevant for regulators, as it examines conditions that might limit the ability of insiders to profit from private information.
Ethan Wang ANU, CIFR / CMCRC Honours Scholarship Program 2014 Keywords: PIN, competition, shareholders
This research study investigates the association between concentration of ownership, degree of industry competition, and level of information asymmetry in stocks listed on the Australian Securities Exchange (ASX). Information asymmetry is defined as the information gap between informed and uninformed traders. Uninformed traders are regarded as those with access to public information only. They are at a significant information disadvantage when trading with their more informed counterparts. According to agency theory, information asymmetry results in conflicts of interest between corporate insiders and outsiders, as managers may not have the incentive to provide precise and informative public disclosure. Thus, information asymmetry is an outcome of the agency relationship, which is explored in this study. The adjusted probability of information-based trades (AdjPIN) is selected as the proxy for information asymmetry. Specifically, a greater AdjPIN value may be expected from a higher level of information asymmetry, as private information underpins information-based trades. Ownership structure and industry competition are identified as two influential factors that motivate managers to publicly disclose material information beyond that required by accounting standards. It is anticipated that firms with more concentrated ownership structures have higher levels of information asymmetry. In contrast, lower levels of information asymmetry are anticipated from firms that operate in highly competitive industries. The objective of this study is to analyse the association between competition in the market, ownership concentration, and information asymmetry, with a view to developing measurable predictions. Previous studies suggest that controlling shareholders have a greater ability to withhold firm-specific material information and to extract private benefits than smaller shareholders. This is a consequence of information asymmetry. Additionally, prior research predicts that firms operating in highly competitive industries have greater incentives to disclose firm-specific information because the cost of publicising proprietary details is relatively low, and may be offset by a transparency benefit in the form of a lower cost of capital. Also, it is anticipated that the information risk suffered by uninformed investors is lower under conditions of higher competition, since increased competition correspondingly promotes the incorporation of private information into stock prices. This study offers three contributions to the existing literature:
  • First, it draws a link between market microstructure and corporate governance. This is common overseas, but rarely done using Australian data. Moreover, the study output is relevant for regulators, as it examines conditions that might limit the ability of insiders to profit from private information.
  • Second, disclosure is commonly recognised as an agency issue. Therefore, it is important to infer the regulatory implications behind these concepts.
  • Third, the study adds to the empirical elaboration of the link between information asymmetry and ownership concentration and industry competition.
Based on the above contributions, this study is motivated by the need to explore the anticipated relations in the context of Australian firms, given that most research on information asymmetry is based on United States data. Furthermore, it has long been predicted that information asymmetry can potentially lead to a higher cost of capital because of higher adverse selection costs generated from uncertainty among market investors. Previous studies have predicted that asymmetric information or information risk is priced into security returns, since uninformed investors require risk premia to compensate for potential losses from trading with their informed counterparts. Thus, an examination of the determinants of information asymmetry may provide some insight into transaction cost implications within the Australian equity market. On a similar note, the literature on market microstructure suggests that asymmetric information can impede market liquidity, resulting in wider bid-ask spreads. Specifically, with a higher degree of asymmetric information among market traders, risk-neutral market makers set a wider spread in order to cover for potential losses from trading against investors who have an information advantage. Thus, it is appealing to investigate how information asymmetry is determined, due to its negative impact on market liquidity and the cost of financing for firms. The extent of ownership and industry concentration are identified as giving rise to important corporate governance mechanisms that may moderate information asymmetry in the Australian capital market. The results of univariate and multivariate analyses show that firms having less concentrated ownership structures and operating in more competitive industries exhibit lower levels of information asymmetry between corporate insiders and outside investors.
Author(s):  Ethan Wang