The interplay of financial reporting quality and investment efficiency: evidence from the USA

Abstract

Purpose This study aims to comprehensively examine the relationship between financial reporting quality (FRQ) and investment efficiency (IE). The central thrust of this research endeavor is to empirically analyze the impact of FRQ on diverse facets of investment, including overinvestment, underinvestment and overall IE. Design/methodology/approach Using a sample of 13,902 firm-year observations from publicly listed US companies, this study uses the generalized method of moment (GMM) in conjunction with three distinct measures for FRQ under three different investment settings, considering firm liquidity and industry performance. Findings This study offers interesting insights into the intricate relationship between FRQ and IE. The results indicate a strong positive relation between the two constructs. In particular, the research reveals a negative link between FRQ and underinvestment, and an inverse relationship between FRQ and overinvestment. These findings suggest that FRQ is one of the key drivers of IE and that by enhancing FRQ, businesses can better optimize their investments. Practical implications This study highlights the significant implication of the effect of FRQ on IE, as it enables businesses to optimize their investments by improving their decision-making processes and better risk assessment of associated projects, resulting in more efficient capital allocation. A higher degree of FRQ increases investors’ confidence in a company’s financial statements, resulting in higher liquidity. It can benefit regulators to set higher standards and promote transparency. Originality/value The study examines the relationship between FRQ and IE. The study finds a strong positive relation between FRQ and IE, with FRQ being a key driver of IE. The paper’s original contribution lies in its comprehensive examination of the complex relationship between FRQ and IE, using robust analytical techniques by applying GMM and taking into consideration firms liquidity and industry performance.