On the Relationship between Peer Firms’ Accounting Quality and Firm-level Capital Investment

Abstract

This study contributes to the literature on the externalities of firms’ financial reporting practices on their peer firm’s decision-making. If managers use their peer firms’ financial disclosures to make investment decisions, it is plausible that their investments are related to peer accounting quality. Using conditional conservatism and discretionary accruals as alternative measures of accounting quality, in a sample of FTSE All-Share Index firms, we find that a firm’s investment level and investment efficiency are both positively associated with its peers’ accounting quality. As an alternative approach to examining this externality, we provide evidence that a firm’s investment level and investment efficiency are both positively associated with its industry’s accounting quality. Additional analysis reveals some differences in the alignments of investment efficiency and conservatism vis a vis accruals quality. Most notably, we find that peer (industry) conservatism is more strongly associated with the efficiency of small-sized relative to large-sized investments, while peer (industry) accruals quality is more strongly associated with the efficiency of large-sized relative to small-sized investments. We attribute this to the differences in which changes in conservatism and accruals quality influence the decision-relevance of accounting information.