On the Use of Instrumental Variables in Accounting Research
David F. Larcker
Stanford University - Graduate School of Business
Tjomme O. Rusticus
London Business School
May 16, 2008
Instrumental variable (IV) methods are commonly used in accounting research (e.g., earnings management, corporate governance, executive compensation, and disclosure research) when the regressor variables are endogenous. While IV estimation is the standard textbook solution to mitigating endogeneity problems, the appropriateness of IV methods in typical accounting research settings is not obvious. Drawing on recent advances in statistics and econometrics, we identify conditions under which IV methods are preferred to OLS estimates and propose a series of tests for research studies employing IV methods. We illustrate these ideas by examining the relation between corporate disclosure and the cost of capital.
Number of Pages in PDF File: 63
Keywords: Endogeneity, instrumental variables, disclosure, cost of capital
JEL Classification: C30, G30, M41, M43
Date posted: April 7, 2005 ; Last revised: November 13, 2009
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