Financial Reporting Quality and Myopic Investments: Theory and Evidence

Abstract

We present theory and empirical evidence that greater financial reporting quality can incentivize
myopic investments. In the model, greater financial reporting quality increases investor response
to earnings, elevating the manager’s incentive to invest myopically to improve earnings. Using the
setting of Big N auditors’ acquisitions of non-Big Ns, which increased investor response to earnings
for the acquired client firms, we find evidence supporting myopic investments. Specifically, acquired
clients decrease intangible investments, particularly when (1) the increase in investor response to
earnings is larger and (2) the horizon of shareholders is shorter. The investment decrease is inefficient, as evidenced by reduced profitability, fewer exploratory innovations, and other measures.

Keywords: financial reporting quality, investment efficiency, real effects, myopia, earnings response coefficient, accounting measurements, intangible investments, patents, innovations

JEL Classification: G14; G34; M41; M42; O31; O34; N22