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On the Use of Instrumental Variables in Accounting Research

63 Pages Posted: 7 Apr 2005 Last revised: 13 Nov 2009

David F. Larcker

Stanford University - Graduate School of Business

Tjomme O. Rusticus

University of Minnesota

Multiple version iconThere are 2 versions of this paper

Date Written: May 16, 2008

Abstract

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

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

David F. Larcker

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

Tjomme O. Rusticus (Contact Author)

University of Minnesota ( email )

Carlson School of Management
321 19th Avenue South, Room 3-122
Minneapolis, MN 55455
United States

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