Financing and Investment Efficiency, Information Quality, and Accounting Biases

In this paper, we investigate the effect of accounting biases on firms' financing decisions and the role of accounting biases in endogenous information quality. We show that in industries with generally low-profit prospects, a downward-biased accounting system performs better than a neutral accounting system, and a more downward bias helps mitigate both investment and financing inefficiency; whereas for industries with generally high-profit prospects, an upward-biased accounting system is better than a neutral accounting system, and a more upward bias helps improve financing efficiency. In addition, we find that a more downward-biased accounting system motivates good firms to exert more effort to improve the information quality, which improves overall efficiency.

This paper was accepted by Mary Barth, accounting.