How Important Is Internal Information Asymmetry for Firm-Level Productivity?

Theoretical research suggests internal information asymmetry (IIA) between top managers and divisional managers can reduce productivity by distorting internal resource allocation. The net effect, however, is unclear because IIA also reflects valuable private information within divisions, and empirical evidence is limited because of the unobservability of managers’ private information sets. Using a measure of IIA that exploits differences in returns to insider trading by top and divisional managers, we find that higher IIA is associated with lower total factor productivity. A one standard deviation increase in IIA corresponds to a 2.6% decrease in productivity relative to industry peers. This effect is comparable in magnitude to other important internal informational frictions, such as internal control weaknesses, and is distinct from internal information quality. Cross-sectional analyses indicate that the negative association is stronger when curative measures are limited and when agency conflicts between top managers and shareholders are greater. Mechanism tests indicate that IIA reduces internal capital market efficiency and increases underinvestment. Finally, using brokerage mergers and closures as a plausibly exogenous shock, we find that increases in IIA lead to declines in productivity. Overall, we provide empirical evidence that IIA is an economically important determinant of firm-level productivity. This paper was accepted by Jan Bouwens, accounting. Supplemental Material: The code and data files are available at https://doi.org/10.1287/mnsc.2024.08526 .