Uncertainty, cost of capital and financial disclosure: A review of the theory and some evidence

Abstract

This paper contains a critical review of the uncertainty research, and reports on the relationship between corporate disclosure and the adverse selection component of the buy-sell (bid-ask) spread of stock prices. Order processing and holding costs will be decoupled from information component following Gloston's definition of spread, and using the George, Kaul and Nimalendran model. Results indicate that there is some evidence of association between the level of disclosure through annual reports and the size of information asymmetry, but further tests for the putative association between the two variables do not show strong linearity.

ACKNOWLEDGEMENTS

The earlier versions of this paper were delivered at the July 2000 Biennial Congress of the Southern African Accounting Association and at the 8, h Annual Conference of the Southern African Finance Association. Valuable comments were received from the participants of those conferences. I am also grateful to Leon Brummer, Willie Hamman, David Fryer, Vanessa Sam and Jenny Doke for supplying data and helping me with the computer.

KEY WORDS:

• Financial disclosure
• information asymmetry
• uncertainty
• risk
• cost of capital
• rational choice
• stock price
• buy-sell spread
• market maker
• Johannesburg Stock Exchange