Information Frictions and Productivity Dispersion: The Role of Accounting Information

• In Event: Financial Markets with Incomplete Information

Abstract

Prior research documents large, persistent differences in productivity across businesses, even within narrowly defined industries, suggesting the presence of economic forces that impede the reallocation of resources from low to high productivity firms. We posit that due to information frictions, capital markets rely more on widely disseminated measures of accounting profitability rather than measures of productivity in their capital allocation decisions, leading to misallocation and hence productivity dispersion when accounting profits do not perfectly map to productivity. Using a large sample of firms in the manufacturing sector, we find that the market’s resource reallocation decisions, measured by firms’ survival as well as capital and labor growth, are indeed more sensitive to ROA than total factor productivity (TFP). We further find that industries with a greater gap between ROA and TFP (i.e., a lower correlation between ROA and TFP) tend to have larger within-industry productivity dispersion, and this relation is stronger for industries with a greater need for external capital. These results suggest that in the presence of information frictions accounting information can play an important role in the reallocation (or misallocation) of resources in part through the financing channel.

Authors

• Rebecca Hann, University of Maryland College Park

• Wen Feng Wang, University of Maryland College Park

• Yue Zheng, University of Maryland