IDEAS home Printed from https://ideas.repec.org/p/hal/journl/hal-00481731.html
   My bibliography  Save this paper

How Does Financial Reporting Quality Relate to Investment Efficiency?

Author

Listed:
  • Gilles Hilary

    (GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique)

  • Gary C. Biddle
  • Rodrigo S. Verdi

Abstract

Prior evidence that higher quality financial reporting improves capital investment efficiency leaves unaddressed whether it reduces over- or under-investment. This study provides evidence of both in documenting a conditional negative (positive) association between financial reporting quality and investment for firms operating in settings more prone to over-investment (under-investment). Firms with higher financial reporting quality also are found to deviate less from predicted investment levels and show less sensitivity to macroeconomic conditions. These results suggest that one mechanism linking reporting quality and investment efficiency is a reduction of frictions such as moral hazard and adverse selection that hamper efficient investment.

Suggested Citation

  • Gilles Hilary & Gary C. Biddle & Rodrigo S. Verdi, 2009. "How Does Financial Reporting Quality Relate to Investment Efficiency?," Post-Print hal-00481731, HAL.
    • Handle: RePEc:hal:journl:hal-00481731
    DOI: 10.1016/j.jacceco.2009.09.001
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Francis, Jennifer & LaFond, Ryan & Olsson, Per & Schipper, Katherine, 2005. "The market pricing of accruals quality," Journal of Accounting and Economics, Elsevier, vol. 39(2), pages 295-327, June.
    2. Malcolm Baker & Jeremy C. Stein & Jeffrey Wurgler, 2003. "When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(3), pages 969-1005.
    3. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    4. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    5. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    6. Paul Gompers & Joy Ishii & Andrew Metrick, 2003. "Corporate Governance and Equity Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 118(1), pages 107-156.
    7. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    8. Blanchard, Olivier Jean & Lopez-de-Silanes, Florencio & Shleifer, Andrei, 1994. "What do firms do with cash windfalls?," Journal of Financial Economics, Elsevier, vol. 36(3), pages 337-360, December.
    9. Dechow, Patricia M., 1994. "Accounting earnings and cash flows as measures of firm performance : The role of accounting accruals," Journal of Accounting and Economics, Elsevier, vol. 18(1), pages 3-42, July.
    10. Mitchell A. Petersen, 2009. "Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches," The Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 435-480, January.
    11. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 2000. "Investment-Cash Flow Sensitivities are Useful: A Comment on Kaplan and Zingales," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(2), pages 695-705.
    12. Dechow, Patricia M. & Kothari, S. P. & L. Watts, Ross, 1998. "The relation between earnings and cash flows," Journal of Accounting and Economics, Elsevier, vol. 25(2), pages 133-168, May.
    13. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    14. Steven N. Kaplan & Luigi Zingales, 2000. "Investment-Cash Flow Sensitivities Are Not Valid Measures of Financing Constraints," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(2), pages 707-712.
    15. Leuz, C & Verrecchia, RE, 2000. "The economic consequences of increased disclosure," Journal of Accounting Research, Wiley Blackwell, vol. 38, pages 91-124.
    16. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March.
    17. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    18. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April.
    19. Verrecchia, Robert E., 2001. "Essays on disclosure," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 97-180, December.
    20. David Aboody & John Hughes & Jing Liu, 2005. "Earnings Quality, Insider Trading, and Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 43(5), pages 651-673, December.
    21. Jones, Jj, 1991. "Earnings Management During Import Relief Investigations," Journal of Accounting Research, Wiley Blackwell, vol. 29(2), pages 193-228.
    22. Edward I. Altman, 1968. "The Prediction Of Corporate Bankruptcy: A Discriminant Analysis," Journal of Finance, American Finance Association, vol. 23(1), pages 193-194, March.
    23. Li, Feng, 2008. "Annual report readability, current earnings, and earnings persistence," Journal of Accounting and Economics, Elsevier, vol. 45(2-3), pages 221-247, August.
    24. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    25. Lambert, Richard A., 2001. "Contracting theory and accounting," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 3-87, December.
    26. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    27. Chang, Xin & Dasgupta, Sudipto & Hilary, Gilles, 2005. "The Effect of Auditor Choice on Financing Decisions," CEI Working Paper Series 2005-10, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
    28. Ole‐Kristian Hope & Wayne B. Thomas, 2008. "Managerial Empire Building and Firm Disclosure," Journal of Accounting Research, Wiley Blackwell, vol. 46(3), pages 591-626, June.
    29. Daniel A. Bens & Steven J. Monahan, 2004. "Disclosure Quality and the Excess Value of Diversification," Journal of Accounting Research, Wiley Blackwell, vol. 42(4), pages 691-730, September.
    30. Gilles Hilary & Sudipto Dasgupta & Xing Chang, 2009. "The Effect of Auditor Quality on Financing Decisions," Post-Print hal-00481935, HAL.
    31. Gilles Hilary & Gary C. Biddle, 2006. "Accounting Quality and Firm-Level Capital Investment," Post-Print hal-00481720, HAL.
    32. Richard Lambert & Christian Leuz & Robert E. Verrecchia, 2007. "Accounting Information, Disclosure, and the Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 45(2), pages 385-420, May.
    33. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    34. Holmstrom, Bengt & Tirole, Jean, 1993. "Market Liquidity and Performance Monitoring," Journal of Political Economy, University of Chicago Press, vol. 101(4), pages 678-709, August.
    35. Ferreira, Miguel A. & Matos, Pedro, 2008. "The colors of investors' money: The role of institutional investors around the world," Journal of Financial Economics, Elsevier, vol. 88(3), pages 499-533, June.
    36. Core, John E. & Guay, Wayne R. & Verdi, Rodrigo, 2008. "Is accruals quality a priced risk factor?," Journal of Accounting and Economics, Elsevier, vol. 46(1), pages 2-22, September.
    37. Kanodia, C & Lee, DH, 1998. "Investment and disclosure: The disciplinary role of periodic performance reports," Journal of Accounting Research, Wiley Blackwell, vol. 36(1), pages 33-55.
    38. Bushman, Robert M. & Smith, Abbie J., 2001. "Financial accounting information and corporate governance," Journal of Accounting and Economics, Elsevier, vol. 32(1-3), pages 237-333, December.
    39. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-233, March.
    40. Healy, Paul M. & Palepu, Krishna G., 2001. "Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 405-440, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Cutillas Gomariz, Mª Fuensanta & Sánchez Ballesta, Juan Pedro, 2014. "Financial reporting quality, debt maturity and investment efficiency," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 494-506.
    2. Juan Pedro Sánchez Ballesta & M. Fuensanta Cutillas Gomariz, 2012. "Financial reporting quality, debt maturity and investment efficiency," Working Papers. Serie EC 2012-07, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
    3. Chan-Jane Lin & Tawei Wang & Chao-Jung Pan, 2016. "Financial reporting quality and investment decisions for family firms," Asia Pacific Journal of Management, Springer, vol. 33(2), pages 499-532, June.
    4. Asiri, Mohammed & Al-Hadi, Ahmed & Taylor, Grantley & Duong, Lien, 2020. "Is corporate tax avoidance associated with investment efficiency?," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    5. Leonard Leye Li & Gary S. Monroe & Jeff Coulton, 2023. "Managerial litigation risk and corporate investment efficiency: Evidence from universal demand laws," Journal of Empirical Legal Studies, John Wiley & Sons, vol. 20(1), pages 196-232, March.
    6. Schleicher, Thomas & Tahoun, Ahmed & Walker, Martin, 2010. "IFRS adoption in Europe and investment-cash flow sensitivity: Outsider versus insider economies," The International Journal of Accounting, Elsevier, vol. 45(2), pages 143-168, June.
    7. Houcine, Asma, 2017. "The effect of financial reporting quality on corporate investment efficiency: Evidence from the Tunisian stock market," Research in International Business and Finance, Elsevier, vol. 42(C), pages 321-337.
    8. Roychowdhury, Sugata & Shroff, Nemit & Verdi, Rodrigo S., 2019. "The effects of financial reporting and disclosure on corporate investment: A review," Journal of Accounting and Economics, Elsevier, vol. 68(2).
    9. Hyun Min Oh & Woo Young Kim, 2018. "The Effect of Analyst Coverage on the Relationship between Seasoned Equity Offerings and Investment Efficiency From Korea," Sustainability, MDPI, vol. 10(8), pages 1-21, August.
    10. Gao, Xin & Xu, Weidong & Li, Donghui & Xing, Lu, 2021. "Media coverage and investment efficiency," Journal of Empirical Finance, Elsevier, vol. 63(C), pages 270-293.
    11. Heidi Quah & Janto Haman & Dharmendra Naidu, 2021. "The effect of stock liquidity on investment efficiency under financing constraints and asymmetric information: Evidence from the United States," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(S1), pages 2109-2150, April.
    12. Karthik Balakrishnan & John E. Core & Rodrigo S. Verdi, 2014. "The Relation Between Reporting Quality and Financing and Investment: Evidence from Changes in Financing Capacity," Journal of Accounting Research, Wiley Blackwell, vol. 52(1), pages 1-36, March.
    13. Cheng, Mei & Dhaliwal, Dan & Zhang, Yuan, 2013. "Does investment efficiency improve after the disclosure of material weaknesses in internal control over financial reporting?," Journal of Accounting and Economics, Elsevier, vol. 56(1), pages 1-18.
    14. Hanif Putra Ardianto & Iman Harymawan & Yuanita Intan Paramitasari & Mohammad Nasih, 2020. "Financial Reporting Quality and Investment Efficiency: Evidence from Indonesian Stock Market," Economics and Finance in Indonesia, Faculty of Economics and Business, University of Indonesia, vol. 66, pages 112-122, Desember.
    15. García Lara, Juan Manuel & García Osma, Beatriz & Penalva, Fernando, 2016. "Accounting conservatism and firm investment efficiency," Journal of Accounting and Economics, Elsevier, vol. 61(1), pages 221-238.
    16. Seyed Sajad Ebrahimi Rad & Zaini Embong & Norman Mohd-Saleh & Romlah Jaffar, 2016. "Financial Information Quality and Investment Efficiency: Evidence from Malaysia," Asian Academy of Management Journal of Accounting and Finance (AAMJAF), Penerbit Universiti Sains Malaysia, vol. 12(1), pages 129-151.
    17. Christian Leuz & Peter D. Wysocki, 2016. "The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research," Journal of Accounting Research, Wiley Blackwell, vol. 54(2), pages 525-622, May.
    18. Imhof, Michael J & Seavey, Scott E., 2018. "How investors value cash and cash flows when managers commit to providing earnings forecasts," Advances in accounting, Elsevier, vol. 41(C), pages 74-87.
    19. Farinha, Jorge & Mateus, Cesario & Soares, Nuno, 2018. "Cash holdings and earnings quality: evidence from the Main and Alternative UK markets," International Review of Financial Analysis, Elsevier, vol. 56(C), pages 238-252.
    20. Armstrong, Christopher S. & Guay, Wayne R. & Weber, Joseph P., 2010. "The role of information and financial reporting in corporate governance and debt contracting," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 179-234, December.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hal:journl:hal-00481731. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: CCSD (email available below). General contact details of provider: https://hal.archives-ouvertes.fr/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.