The effect of accounting information quality and competition on investment inefficiency: evidence from Korea^*

* Accepted by Jeong-Bon Kim recommendation by Junbo Wang.

Abstract

We examine whether either accounting quality or competition mitigates against firms’ investment inefficiency, and whether the association between accounting quality and investment inefficiency depends on the level of competition. In this paper, an analysis is undertaken of firms listed on the Korean Stock Exchange (KSE) from 2000 to 2010. The Korean economy is characterized by the ‘Chaebol’ and dominated by a creditor-oriented financing system, such that creditors have strong control over firms’ investment decisions. We believe that our own empirical results illustrate an interesting case study of the Chaebol-/bank-dominated economy, and provide additional data in this regard for academic research. Our results show that firstly, and as expected, accounting quality and competition mitigate against investment inefficiency. Managers of firms that have a higher level of accounting quality make capital investment decisions more efficiently, and their BODs monitor managers’ decision-making more effectively. For a higher level of competition in a given industry, high liquidation risks force managers to decide on capital investment more efficiently. Secondly, it is shown that accounting quality causes improvements in investment inefficiency where the level of competition in a given industry is low.

Keywords:

• Capital investment
• accounting information quality
• competition
• discretionary accruals
• corporate governance

Notes

* Accepted by Jeong-Bon Kim recommendation by Junbo Wang.

1. Empire-Building implies self-promotional behavior in which a manager exercises power and pursues his/her own wellbeing.

2. Price protection implies that the principal anticipates the opportunistic behavior of agents and this is reflected in the price under the reasonable expectation of agency relationships.

3. Accounts information not only includes data on sales and cost of materials, but labor, pricing structure, etc.

4. Those systems have largely effect on capital markets in Korea and our samples are equally affected by those systems.

5. We exclude firms where the total capital is less than the par value of all their capital stock.

6. We consider all private and public firms when calculating HHI because firms have to compete with all competitors regardless of their listed status. The mean value of HHI is 0.065, as reported in Table 1, and this value is similar to that seen in prior studies that included both private and public companies. For example, the mean value of HHI was respectively 0.059 and 0.07 in Cheng, Man and Yi (2013) and Stroughton, Wong, and Yi (2015). We also re-examined HHI covering public firms only and confirmed that the results were similar.

7. Song (2002) reported that financing patterns have changed from external to internal since the IMF economic crisis in Korea and most investment decision-making now focuses on profitability and stability rather than growth.