The Effects of Financial Reporting and Disclosure on Corporate Investment: Analysis and Critique

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The purpose of this paper is to present an analysis and critique of Roychowdhury, Shroff, and Verdi’s The effects of financial reporting and disclosure on corporate investment: A review (Journal of Accounting & Economics, 68 (2019)). Roychowdhury, Shroff, and Verdi survey the empirical literature over the previous two decades on “whether and to what extent financial reporting facilitates the allocation of capital to the right investment projects,” “provide a framework to organize this literature,” and “highlight opportunities for future research.” The framework they provide for organizing the literature “articulate[s] two broad scenarios in which financial reporting ‘matters’ for investment choices: (i) the presence of information asymmetry that gives rise to agency frictions such as adverse selection and moral hazard costs, and (ii) the presence of uncertainty about growth opportunities.” The analysis and critique presented herein addresses the framework and the first scenario. In particular, it focuses on what they refer to as agency frictions and the opportunities they suggest for future research. While the question of whether and to what extent financial reporting facilitates the allocation of capital to the right investment projects is important and worthy of future research, the framework and first scenario present several problems that cannot easily be ignored if the opportunities for future research are to be pursued.