Financial reporting quality, Political connection, and Investment Efficiency

Abstract

A key question in corporate finance is what motivates investment in the firms. In Modigliani and Miller's (1958) ideal world, the investment policy of a firm is exclusively determined by the investment prospects it follows, as evaluated by Tobin in 1969. The literature has however long acknowledged that enterprises in the actual world vary from the optimal investment behaviour because of many animosities. Based on the perspective of agency theory, Two types of frictions are studied in theoretical models and practical studies: information asymmetry (Chen et al., 2007) and agency issues (Stein, 2003), which define the company as a contract collecting agency (a contract's nexus) that relationships between individuals. A substantial amount of work in the literature demonstrates that information asymmetry can be reduced by businesses. by improving financial reporting quality (Healy & Palepu, 2001, Bushman & Smith, 2001). According to the line of research done by Biddle and Hilary in 2006, Mc Nichols and Stubben in 2008, Biddle in 2009 and Chen in 2011, better frq increases the IE by reducing the adverse selection and peril which also allows managers to identify better investment opportunity for the firm. “Shorter debt maturities have been proposed as a method to reduce the information asymmetry issues as the lenders think that the firms can obtain better price conditions during loan renewals and can signal that they are good; and because from the lender's perspective, shorter maturities permit improved managerial control and monitoring . Political connections with the firms have also received much interest in recent years.