The Effect of Private Information and Monitoring on the Role of Accounting Quality in Investment Decisions

35 Pages Posted: 3 Nov 2009

See all articles by Anne Beatty

Anne Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Scott Liao

University of Toronto - Rotman School of Management

Joseph Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: June 30, 2009

Abstract

We investigate how private information and monitoring affect the role of accounting quality in reducing the investment-cash flow sensitivity. We argue that access to private information and direct restrictions on investments are likely to affect the extent to which accounting quality reduces financing constraints. Our results suggest that for financially constrained firms, banks’ access to private information decreases the value of accounting quality. We further find that, for both financially constrained and unconstrained firms, covenants directly restricting capital expenditures also mitigate the importance of accounting quality. Our results suggest that when information asymmetry problems are likely to be the largest, accounting quality is most important. However, the importance of accounting quality is mitigated if outside capital suppliers have access to private information and is eliminated if they impose contractual restrictions on investment. We also provide evidence that banks’ access to private information reduces the cash flow sensitivity of cash and mitigates the importance of accounting quality in reducing this sensitivity. This additional evidence suggests that our investment-cash flow sensitivity results are not driven by measurement error of the investment opportunity set.

Keywords: Private information, Monitoring, Accounting Quality, Investment

JEL Classification: D82, M41

Suggested Citation

Beatty, Anne L. and Liao, Wei-Yi (Scott) and Weber, Joseph Peter, The Effect of Private Information and Monitoring on the Role of Accounting Quality in Investment Decisions (June 30, 2009). Available at SSRN: https://ssrn.com/abstract=1499307 or http://dx.doi.org/10.2139/ssrn.1499307

Anne L. Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

Wei-Yi (Scott) Liao (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Joseph Peter Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States
617-253-4310 (Phone)

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