The Effect of Private Information and Monitoring on the Role of Accounting Quality in Investment Decisions

Abstract

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.