Adverse Selection in the Capital Market

In capital market when securities like equity shares are issued, investors like to buy the shares of those companies which have a sound financial position. However, most of the investors, especially the small investors are not well about the exact financial position of the company while the managers of the company are fully aware about the financial position of their company. In such a situation, the companies whose financial position is not very well tend to hide their exact financial position and release insufficient information in the market. As a result, investors may end up buying shares which will fetch them lower profitability.
Or, since investors know that there is presence of both high quality and low quality shares, but they do not exactly which the low quality ones are, they might end up buying no securities at all. This leads to inefficiencies in the capital market. This problem specially hurts the small investors in the market who do not have enough funds to hire experts. This is the reason why very few people participate in the share market.