Financial reporting quality, capital allocation efficiency, and financing structure: An international study

I examine the relation between financial reporting quality and capital allocation efficiency across twenty-three countries. Previous literature suggests that outside shareholders reduce information asymmetry by requiring extensive financial reporting, while insiders, such as banks, more frequently use private communication channels. I hypothesize that high quality financial reporting improves capital allocation decisions, but its usefulness increases (declines) with equity (bank) financing. I find that a country's legal, political, and economical infrastructure improves the country's capital allocation efficiency. Financial reporting quality over and above that predicted by the infrastructure improves capital allocation efficiency for industries more dependent on equity financing. My findings are consistent with a heterogeneous demand for accounting information. Outside shareholders are more dependent on financial reporting to reduce information asymmetry than are banks.