63 Pages Posted: 7 Apr 2005 Last revised: 13 Nov 2009
Date Written: 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.
Keywords: Endogeneity, instrumental variables, disclosure, cost of capital
JEL Classification: C30, G30, M41, M43
Suggested Citation: Suggested Citation
Larcker, David F. and Rusticus, Tjomme O., On the Use of Instrumental Variables in Accounting Research (May 16, 2008). Available at SSRN: https://ssrn.com/abstract=694824 or http://dx.doi.org/10.2139/ssrn.694824