How Does Financial Reporting Quality Relate to Investment Efficiency?

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.

Keywords: Financial Reporting Quality, Investment Efficiency, Accounting Quality, Adverse Selection, Moral Hazard

JEL Classifications: G30, G31, M41, M43, D82

Working Paper Series