The Role of Financial Reporting Quality in Mitigating the Constraining Effect of Dividend Policy on Investment Decisions
University of Georgia - Terry College of Business
National Taiwan University - The Department and Graduate Institute of Accounting
University of Texas at Austin
September 28, 2012
Accounting Review, Forthcoming
Miller and Modigliani’s (1961) dividend irrelevance theorem predicts that in perfect capital markets dividend policy should not affect investment decisions. Yet in imperfect markets, external funding constraints that stem from information asymmetry can force firms to forgo valuable investment projects in order to pay dividends. We find that high quality financial reporting significantly mitigates the negative effect of dividends on investments, especially on R&D investments. Further, this mitigating role of financial reporting quality is particularly important among firms with a larger portion of firm value attributable to growth options. In addition, we show that the mitigating role of high quality financial reporting is more pronounced among firms that have decreased dividends than among firms that have increased dividends. These results highlight the important role of financial reporting quality in mitigating the conflict between firms' investment and dividend decisions and thereby reducing the likelihood that firms forgo valuable investment projects in order to pay dividends.
Number of Pages in PDF File: 52
Keywords: Financial Reporting Quality, Dividends, InvestmentsAccepted Paper Series
Date posted: January 2, 2013 ; Last revised: January 9, 2013
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