Knowing exactly how much profit they can expect to achieve, these companies will know for sure what the selling price per share is reasonable. Because in addition to the method of determining stock price by asset value 5 , there is also a method of determining stock price by dividend 6. Therefore, if investors do not accurately determine the expected dividend of a listed company, the stock price will be inaccurate and if the price is higher than the actual value of the stock, the disadvantage is entirely on the investor.
2.3.3.2. Dependent psychology
The second consequence of asymmetric information is the psychology of dependence, which 'appears due to concealed behavior and appears after signing the contract' (Nguyen Trong Hoai, 2006).
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With bank loan or insurance contracts, the psychology of dependence arises from the borrower or the person buying insurance. They use the loan for the wrong purpose or because they have been insured, they will be more careless than before buying insurance. In the stock market, the psychology of dependence arises if the company's representatives do not use capital effectively and for the right purpose. Due to the nature of investment in the market being indirect investment, the management and supervision of investment capital of investors must go through a number of representatives to run the company. The psychology of dependence will increase if the percentage of shares owned by the representatives is low. Because if the production and business activities are not effective, their responsibility is not high and the loss on the contributed capital is low. Therefore, currently, the first criterion for shareholders who want to be members of the Board of Directors is that they must have a certain percentage of contributed capital.
2.3.4. The impact of asymmetric information on investors
The impact of asymmetric information on investors is as follows:
5 Share price is equal to net asset value divided by total number of shares issued.
6 The stock price is equal to D 1 /r or D 1 /(rg). Where D 1 is the dividend for year 1, r is the discount rate, and g is the constant growth rate of the dividend. In other cases, there will be corresponding formulas.
- 'The benefit of one party is higher than the expected benefit of the market' (Nguyen Trong Hoai, 2006): The expected benefit of the market is the average benefit of the whole market, it is often evaluated through indexes such as EPS 7 or P/E index 8. However, for each company, based on the growth rate of revenue, profit... these indexes are high or low. Normally, the expected benefit when investing in the market must be higher than the benefit when depositing money in the bank, because investing in the market
The stock market is riskier. Therefore, if an investor buys shares of a company at a price lower than the expected price, then the possibility of getting a return on the investment in this stock will be higher than the expected return.
- 'The expected cost of the information disadvantage party is higher than the expected cost of the market' (Nguyen Trong Hoai, 2006): in contrast to the above effect, if an investor buys shares of a company with a price higher than the expected value, then the possibility of achieving a return from investing in this share will be lower than the expected return.
- 'One partner may leave the market' (Nguyen Trong Hoai, 2006): because investors have little information, they will bear higher expected costs than the market expected costs, so more or less, these subjects will be the first to leave the market.
2.3.5. Theoretical solutions to limit information asymmetry
In many fields where information asymmetry appears, the solutions commonly applied to limit the level of information asymmetry are signaling mechanisms, screening mechanisms and monitoring mechanisms (Nguyen Trong Hoai, 2006):
2.3.5.1. Signaling
For the financial market, to trade effectively, borrowers can borrow capital at low costs, lenders are sure of the ability to recover debts, and lenders and borrowers must clearly understand their own rights and responsibilities. Usually, borrowers are the ones who know the most about themselves, so
7 Earnings per share.
8 Stock price divided by earnings per share.
They will benefit more in the transaction. However, banks will not easily lend if they do not know about their customers. Therefore, borrowers must signal that they are capable of repaying debts. The signaling problem in this case is: Company reputation, company size and reputation, financial capacity, collateral, etc. In return, banks must also signal for borrowers to fulfill their responsibilities in the loan contract such as asset handling mechanism, loan interest rate, etc.
Just like the financial market, when investors buy shares of a company listed on the stock market, they more or less need to know how the company operates, what it produces, etc. Therefore, if a company wants to improve its position, sell shares at a high and reasonable price, it must show investors its reputation, operating efficiency and development potential.
2.3.5.2. Screening
To limit their adverse selection, banks often apply different credit limits to each borrower, loan project and loan term. For insurance organizations, the screening mechanism is demonstrated by only partial insurance, which shows that even the careless group must take part of their responsibility in the possible compensation incident. In the stock market, except for some speculators, most investors want to invest in companies that are capable of bringing high and sustainable efficiency. Therefore, the screening mechanism for investors is to invest in companies with transparent information, reputation, effective business and high growth potential.
2.3.5.3. Monitoring mechanism
The monitoring mechanism is applied to control the psychology of dependence, the mechanism includes: direct monitoring and indirect monitoring:
- Direct supervision: investors will spend resources to achieve information control, this supervision mechanism costs a lot of money and effort, the supervision ability of investors who want to supervise listed companies will be limited.
- Indirect supervision: through the regulations of market organizers (SC, SE), listed companies are automatically responsible for directly or indirectly informing investors and investors can also access indirect supervision of listed companies through the prescribed rights. In addition, there is market supervision: based on market assessments to know more information about listed companies after transactions.
The monitoring mechanism is implemented very strictly in the stock market. Because investors cannot spend money without knowing how that money is used.
Before signing the contract
Covered information
Figure 2.1: Summary of asymmetric information model
After signing the contract
Cover-up behavior
Asymmetric information
Adverse selection
Mentality
rely on
Indirect mechanism
Direct mechanism
Screening
Signal
Source: Nguyen Trong Hoai (2006)
2.4. Empirical studies measuring information asymmetry
2.4.1. Model for determining adverse selection costs
1) Glosten and Harris (1988)
According to the two men, the range of transaction price variation ( Bid-ask pread) includes three components: adverse selection cost component, processing cost component.
order placement and storage cost components (Chung et al., 2006, pp.7-8). The model for determining adverse selection costs is established based on the variation of transaction prices at different points in time.
P t – P t-1 c 0 (Q t - Q t-1 ) + c 1 (Q t V t - Q t-1 V t-1 ) + z 0 Q t + z 1 Q t V t + jt . In which: P t and P t-1 : are the stock prices at time t and t-1.
Q t : The trading index of the stock at time t, Q t equals +1 if you are a buyer and equals -1 if you are a seller.
V t : Volume of stock transactions at time t. c 0 , c1, z 0 , z 1 : are coefficients of the equation.
jt : is the error of the equation.
The adverse selection cost is Z 0 = 2(z 0 + z 1 V t ), the remainder: order processing cost and storage cost are C 0 = 2(c 0 + c 1 V t ).
To estimate the adverse selection cost component for each stock i,
Glosten and Harris used the average trading volume ( V t ) of stock i to
Calculate the adverse selection component in the price variance component using the following formula:
ASC = 2(c 0 + c 1 V t )/ 2(c 0 + c 1 V t ) + 2(z 0 + z 1 V t )]
2) George Kaul and Nimalendran (1991)
George Kaul and Nimalendran developed a method to decompose the volatility of the trading price into two main components, the adverse selection cost component and the order processing cost component, with the remaining storage cost being considered negligible (Clarke and Shastri, 2001). The model determines the adverse selection cost based on the difference between the profit earned at the matched price and the profit at the average price.
2RD t = 0 + 1 (s qt Q t - s qt-1 Q t-1 ) + t
= 1 - 1
In there:
RD t is the difference between the profit obtained at the matched price and the profit at the average price.
is the adverse selection cost component.
s qt ratio between the variation of the transaction price (spread) and the transaction price.
Q t : The trading index of the stock at time t, Q t equals +1 if you are a buyer and equals -1 if you are a seller.
jt : is the error of the equation.
3) Lin, Sanger and Booth (1995)
Lin, Sanger and Booth also assume, like George Kaul, and Nimalendran (1991), that the storage cost component is negligible over the range of transaction prices and therefore need not be considered. Consider the variation in transaction prices as reflecting the order processing cost component, while the pricing reflects the adverse selection cost component (Clarke and Shastri, 2001). The model for determining adverse selection costs:
M t+1 – M t = Z t + j+1 Z t+1 = Z t + t+1 In which:
Average winning price
is the adverse selection cost Z t = P t - M t (P t transaction price)
= ( + 1)/2 is the order processing component
j+1 and t+1 are random errors
4) Roger D.Huang and Hans R.Stoll (1997)
By developing the model of Madhavan, Richardson, and Roomans (1997), Roger D.Huang and Hans R.Stoll analyzed the model of determining adverse selection costs according to the transaction index factor. In this model, the authors considered the factor of two-way transactions between the seller and the initial buyer. The analytical model is divided into two levels (Clarke and Shastri, 2001). The basic regression model is as follows:
Δ P S ( Q Q ) S Q e
t 2 t 1 2 t 1 t
In there:
Δ P t is the change in transaction price at time t and t-1 S is the price fluctuation constant (constant spread)
Q t : The stock's trading index at time t, Q t equals +1 if the transaction is a buyer and the trading price is greater than the average price (average price = ½ (lowest trading price + highest trading price), equals -1 if the transaction is a seller and the trading price is less than the average price, equals 0 when the trading price is equal to the average price.
= + , is the adverse selection cost, is the storage cost. e t is the error.
Because it is not possible to separate � as adverse selection cost and � as storage cost
in coefficient Therefore, the determination of α must be based on the following extended regression model:
Δ M ( ) S t 1 ( Q ) (1 2 ) S t 2 Q e
t 2 t 1 2 t 2 t
E(Q t-1 Q t-2 ) = (1-2 )Q t-2
In there:
M t is the average bid price
E(Q t-1 Q t-2 ) 9 is the expectation of Q t-1 with respect to Q t-2
is the probability of the opposite transaction occurring.
9 The expected value can be calculated: Q t-1 = Q t-2 with probability (1- ) and Q t-1 = - Q t-2 with probability (Roger D.Huang and Hans R.Stoll, 1997 cited in Clarke and Shastri, 2001).
In addition, 2 models are also used by many studies such as: Madhavan, Richardson and Roomans model (1997), Easley, Kiefer, OHara and Paperman model (1996).
2.4.2. Regression functions and variables measuring asymmetric information
1) Brennan and Subrahmanyam (1995)
Brennan and Subrahmanyam's main research is the study of the relationship between the number of analysts covering a stock and the cost of adverse selection in stock trading. Inheriting the research of previous authors such as Kyle (1985), Admati and Pleideter (1988), Bhushan (1989)..., especially Brennan and Subrahmanyam inherited and developed the simultaneous regression function of Admati and Pleideter as follows:
LTC = a 0 + a 1 LANAL + a 2 LVOL + a 3 LPRI + a 4 LVAR + e TC [1.1]
5
LANAL = b 0 + b 1 LTC + b 2 LVAR + b 3 LSIZE + b 4 LPRI +
i 1
b i+5 IND +
b 9 LPINST + b 10 LINST + e ANAL [1.2]
LVOL = g 0 + g 1 LTC + g 2 LANAL + g 3 LSIZE + e ERR [1.3]
In which: Function [1.3] is the function that Brennan and Subrahmanyam developed. The information variables in each equation are: LTC is the log of adverse selection cost/price, LANAL is the log of (1 + number of analysts), LVOL is the log of the average daily trading volume, LSIZE is the log of the average daily market value of the stock, LVAR is the log of the error of the daily return (price range), LPRI is the log of the average daily price, LINST and LPINST are the log of the number of institutions in the company and the log of the percentage of the number held by institutions, INDi is a dummy variable belonging to one of the five industries classified by COMPUSTAT.
Through empirical research Brennan and Subrahmanyam found that the relationship between LANAL and LTC is negative and highly significant (same result as Kyle, 1985). This Brennan and Subrahmanyam argued that as the number of analysts increases, the cost of adverse selection will decrease because more analysts will have more information to analyze. That is what makes information about the company