The Effect of Private Information
The Effect of Private Information and Monitoring on the Role of Accounting Quality in Investment Decisions*
ANNE BEATTY, The Ohio State University W. SCOTT LIAO, University of Toronto JOSEPH WEBER, Massachusetts Institute of Technology
1. Introduction Information asymmetry between managers and outside capital suppliers can affect how firms finance capital investments. A growing body of evidence indicates that better accounting quality can reduce information asymmetry costs and reduce financing constraints. Consistent with this possibility, Biddle and Hilary (2006) document that higher accounting quality reduces the sensitivity of firms’ investment to their internally generated cash flows. Verdi (2006) and Biddle, Hillary, and Verdi (2009) find that accounting quality is positively correlated with investment for firms prone to underinvest and is negatively correlated with investment for firms prone to overinvest. The importance of accounting quality on investment inefficiency may be mitigated when outside capital suppliers have private information or can directly monitor managers. By accessing private information and controlling managerial actions, outside capital suppliers can directly affect a firm’s investments, reducing the importance of accounting quality. Consistent with this idea, Biddle and Hilary (2006) compare the influence of accounting quality on investment efficiency across countries. They find that accounting quality influences investment efficiency in the United States, but not in Japan. They suggest that one potential explanation for this cross-country difference is the mix of debt and equity in the capital structures of U.S. versus Japanese firms. We extend this research by examining how different sources of financing affect the importance of accounting quality on firms’ investment–cash flow sensitivity. Directly testing how different sources of financing influence the
* Accepted by Shivaram Rajgopal. Beatty thanks Deloitte & Touche for financial support. We thank
ANNE BEATTY, The Ohio State University W. SCOTT LIAO, University of Toronto JOSEPH WEBER, Massachusetts Institute of Technology
1. Introduction Information asymmetry between managers and outside capital suppliers can affect how firms finance capital investments. A growing body of evidence indicates that better accounting quality can reduce information asymmetry costs and reduce financing constraints. Consistent with this possibility, Biddle and Hilary (2006) document that higher accounting quality reduces the sensitivity of firms’ investment to their internally generated cash flows. Verdi (2006) and Biddle, Hillary, and Verdi (2009) find that accounting quality is positively correlated with investment for firms prone to underinvest and is negatively correlated with investment for firms prone to overinvest. The importance of accounting quality on investment inefficiency may be mitigated when outside capital suppliers have private information or can directly monitor managers. By accessing private information and controlling managerial actions, outside capital suppliers can directly affect a firm’s investments, reducing the importance of accounting quality. Consistent with this idea, Biddle and Hilary (2006) compare the influence of accounting quality on investment efficiency across countries. They find that accounting quality influences investment efficiency in the United States, but not in Japan. They suggest that one potential explanation for this cross-country difference is the mix of debt and equity in the capital structures of U.S. versus Japanese firms. We extend this research by examining how different sources of financing affect the importance of accounting quality on firms’ investment–cash flow sensitivity. Directly testing how different sources of financing influence the
* Accepted by Shivaram Rajgopal. Beatty thanks Deloitte & Touche for financial support. We thank
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