The Real Effect of Disclosure on Company Decisions: Evidence from Portfolio Choices of Investment Companies

• In Event: Financial Statement and Earnings Management Disclosures

Abstract

This paper investigates how the quality of financial disclosures impacts the portfolio choices of domestic and foreign investment companies. I implement an exogenous shock to the quality of financial reporting in European equity markets and examine the portfolio choices of global investment companies in the pre and post periods. I find that foreign investment companies significantly improve their stock-picking skills after the shock, in contrast to domestic ones whose skills deteriorate afterward. The change in the relative performance between domestic and foreign investment companies is more profound in stocks with larger information asymmetries, and in stocks whose business complexity is more severe. My results contribute to the positive accounting theory by showing that the aggregated information in financial disclosure could help investors making better investment decisions. However, to improve the disclosure quality may not make all investors better off. Instead, the role financial reporting serves is to level the playing field between different groups of investors. I thus provide direct evidence on how disclosure quality improves market efficiency and capital allocation.

Author

• Zhe Wang, Georgia State University