We had a very interesting discussion with Gilles Hilary and Rodrigo Verdi on their paper linking better financial reporting quality to less overinvestment among firms with lots of cash on hand and less underinvestment among firms with lots of leverage.  It sparked a number of questions, so of which I recount here:

  • What specific aspects of reporting quality drive improved investment decisions?  Like so many archival studies, this one uses very broad measures of financial reporting quality.  One uses the Dechow-Dichev metric on the association between income and previous, current and future cash flows; another uses Wycocki’s modification, yet another looks at the readability of the 10-K, a la Feng Li.  But none of those seem to capture the specific agency problems that distort investment.  What would be more targeted?
  • To the extent that financial reporting improves firms’ investment decisions, should we think of this as satisfying a “stewardship” objective, rather than (or in addition to) decision-usefulness for investors?  Either way, how useful would (or should) the FASB find evidence associating financial reporting quality with the optimality of investment decisions?

We had time for plenty of other questions, and some interesting answers.  Hopefully we will see some of those raised in the comment thread.