Information asymmetry and capital structure around the world

•Firms with greater information asymmetry use more leverage and short-term debt.•The cost of equity is more sensitive to information asymmetry than the cost of debt.•Strong institutions attenuate the information impact on leverage.•Strong institutions mitigate the information impact on cost differential.•The main findings are robust to an exogenous event of IFRS adoption.

This paper examines the relation between information asymmetry, capital structure and the cost of capital across countries, particularly focusing on how the relation is influenced by the various aspects of the institutional environment. Results show that firms with high levels of information asymmetry tend to use more debt capital but less long-term debt, possibly because of the differential impact of information asymmetry on the cost of different types of capital. Furthermore, the positive association between information asymmetry and market leverage is more pronounced in countries with developed banking sectors or with explicit bankruptcy codes, and less prominent in common-law countries and countries with sound law enforcement or with extensive disclosure practices.