THE RELATIONSHIP BETWEEN CAPITAL ALLOCATION EFFICIENCY AND FINANCIAL REPORTING QUALITY: INTERNATIONAL EVIDENCE

Kevin Sun
St. John’s University
ABSTRACT
This study examines the relation between the quality of financial reporting and efficiency
of capital allocation. Capital allocation efficiency is defined as the magnitude of capital movement
out of low-return projects and into high-return projects. Previous literature found that ineffective
monitoring and information asymmetry may cause a lack of capital movement in response to
changes in investment opportunities. This paper, based on analyses across twenty-eight countries,
shows that high-quality financial reporting can increase capital allocation efficiency. Since the
efficiency of capital allocation is a necessary condition for economic growth, this study suggests a
setting in which financial accounting quality is expected to have real economic effects.