52 Pages Posted: 2 Jan 2013 Last revised: 9 Jan 2013
Date Written: September 28, 2012
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.
Keywords: Financial Reporting Quality, Dividends, Investments
Suggested Citation: Suggested Citation
Ramalingegowda, Santhosh and Wang, Chuan-San and Yu, Yong, The Role of Financial Reporting Quality in Mitigating the Constraining Effect of Dividend Policy on Investment Decisions (September 28, 2012). Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2195739
By Ray Ball