You Don't Know What You Don't Know: Improvements in Investment Efficiency Prior to a Mandated Accounting Change

Abstract

Theory suggests mandated changes in accounting standards can increase investment efficiency through two mechanisms: (1) increases in internal information quality (IIQ), and/or (2) increases in external information quality (EIQ). We leverage the transition period of the new lease accounting standard, where EIQ is unlikely to change, to isolate the effect of increases in IIQ on investment efficiency. Using a difference-in-differences design, we find that firms affected by the new lease standard experience improvements in investment efficiency in the year immediately preceding the standard’s implementation. Cross-sectional tests suggest the investment efficiency gains are driven by IIQ reducing internal moral hazard risk. We contribute to the investment efficiency literature by isolating the effect of increases in IIQ on investment behavior and identifying a specific channel through which IIQ affects investment efficiency. Further, we document that preparing to comply with an accounting standard change improves managerial decision-making, which may be of use to the FASB as part of their post-implementation review of the lease accounting standard.