Taming Information asymmetry

BY TAFARA MTUTU

INFORMATION asymmetry is a condition in which one party has more information than other parties that there are conducting business with. This phenomenon is prevalent in almost every area of business and it introduces business risks such as adverse selection. Adverse selection is a situation in which information asymmetry results in inefficiencies in a business or market.

This is usually observed in insurance companies, where insurers raise premiums for a specific group of people to cater for undisclosed material information that could expose the business to large claims.

As a result, clients whose risk profile falls below the level of premiums being quoted tend to walk away, leaving the insurer with only high-risk individuals for that specific group of individuals in what becomes a prime case of adverse selection. In other markets, information asymmetry often results in fragmented markets, where varying prices exist for the same product. This is often compounded by a lack of platforms such as e-commerce sites and stock exchanges that allow market forces to efficiently determine the price of goods and services.

Information asymmetry also manifests itself in capital markets between the shareholder and the management of a company, where management is typically better informed about the state of the business, given their direct access and influence on daily operations. This phenomenon is less visible, albeit notable, in listed equities and bonds.

Listed companies and other capital market players such as stockbrokers have increasingly put measures to address information asymmetry that include comprehensive financial and reporting, discussions with management, site visits and analyst coverage, but these efforts remain inadequate to fully address the skewed distribution of material information about an investment.

Mandatory corporate disclosures significantly reduce information asymmetries and, subsequently, an entity’s overall risk.
This also underpins the difference in investment risk and valuations between a listed business and a similar unlisted business. Globally, the level of disclosures has improved to include ESG and sustainable reporting under the Global Reporting Initiative (GRI) framework. From a macro-economic perspective, Zimbabwe is also levelling up, albeit at a much slower pace.

According to the 2020 Global Real Estate Transparency Index (GRETI) by JLL and LaSalle, Zimbabwe does not feature among the 99 countries that make the index. The GRETI measures the transparency of real estate markets using parameters such as governance of listed companies, availability of market data, legislation, and sales processes.

Some of the more transparent African economies featured on this list include South Africa (ranked 24th out 99), Mauritius (51st), Kenya (52nd), Botswana (53rd), and Rwanda (78th), among many others. These countries are also among the most stable economies on the continent according to the 2020 Fragile States Index by a non-government organisation called Fund For Peace.

The list ranks Mauritius as the least fragile economy in 2020, followed by Botswana, Ghana. Namibia, Tunisia, Gabon, South Africa, Morocco, and Senegal, just to name a few. Zimbabwe currently ranks as the 10th most fragile state in the world on the index. The similarities in countries on these two lists paint a subtle-but-convincing relationship between information asymmetry and economic stability.

On a micro-economic level, we have observed that some entities in Zimbabwe, especially those listed on the different stock exchanges, have less information asymmetry. Most listed entities in Zimbabwe’s stock exchanges with foreign shareholding tend to exhibit comprehensive corporate disclosures and governance reports.

These companies include African Sun (foreign shareholder: Arden Capital), Delta Corporation (AB InBev), NMBZ Holdings (Arise B.V), and Old Mutual Zimbabwe (Old Mutual Limited). Other listed companies, (Innscor, ART Corporation, Axia, Dairibord, First Mutual Properties, Masimba, National Foods, Padenga, RTG, SeedCo, SeedCo International, Simbisa Brands, Turnall, Zimplow) do not have significant foreign shareholding but they have also taken the step to adopt the Global Reporting Initiatives (GRI) standards which require comprehensive disclosures.

In bond markets, information asymmetry has also been documented as a source of risk. Using US data between 2001 and 2006, researchers Lu, Chen and Liao (2010) found empirical evidence of investors charging a significant risk premium for information uncertainty and asymmetry in corporate bonds. However, we need not dwell much on this in Zimbabwe’s context for now given that the country’s corporate bond market is virtually non-existent.

Extensive studies on information asymmetry have also given rise to interpretation of management decisions as signals that investors take advantage of in evaluating their investments. For example, a company’s management decision to change its dividend policy usually sends signals to investors about the information that management holds.

If a business decides to start declaring dividends, this suggests that management is in possession of information that support the notion that the business will experience sustained good performance going forward.

In the same vein, when a consistently dividend-paying entity decides to suspend dividends indefinitely, investors perceive that management knows something about the company that suggests it cannot sustain historic performance in the foreseeable future.

A good example of this effect is Rainbow Tourism Group. The ZSE-listed hospitality and tourism stock battled periodic losses between 2006 and 2016 and paid no dividend during the period.

On April 30 2019, it declared a dividend and the share price of the company jumped 59,8% from US$0,43 on April 29 to US$0.68 on May 6 2019. The counter currently trades on a USD equivalent of 2,01 US cents despite the impact of the pandemic on tourism stocks. An executive director’s purchase of his/her employer’s shares is another positive signal that investors look out for given the information asymmetry that is typically skewed toward company executives.

Steady progress towards market efficiencies through information symmetry continues to be done. Insurance companies, for example, have now begun rolling out products that reward individuals with healthy lifestyles and good driving habits, which can be tracked through accelerometer, gyroscope, and GPS data as well as smart watches.

These digital insurance products, such as Discovery’s telematics-based car insurance, are increasingly growing in popularity. There has also been an increase in e-commerce platforms that reduce the level of information asymmetry in virtually every market. Such platforms include Amazon, Takealot and Alibaba.

ln Zimbabwe, there has been a rise in online platforms such as Cassava’s Ownai, new exchanges (FINSEC and Victoria Falls Stock Exchange, VFEX) as well as other exchanges in the pipeline (Zimbabwe Emerging Enterprises Market and Zimbabwe Mercantile Exchange).

We also note that executives employed by listed entities such as FBC Holdings and Delta have been purchasing stocks of the companies that they lead, and this has positive signals about the companies’ future earnings prospects.

The advent of the internet era has also compounded these strides as they have made more information available at the fingertips of any user with an internet-enabled device.

However, achieving complete information asymmetry is quite impossible without infringing on privacy rights, and it becomes a matter of balancing between the two.

  • Mtutu is a research analyst at Morgan & Co. He can be reached on +263 774 795 854 or tafara@morganzim.com