Earnings Quality and Investment Efficiency: Evidence from Eastern Europe

Abstract

This study explores the firm-level relationship between earnings quality and investment efficiency. Higher quality of reported results has the capacity to positively impact the efficiency of company's investment levels by over-and underinvestment reduction. The research is carried out on the sample of 7546 companies from Eastern Europe for the period 2010-2015. Eastern European countries have a unique institutional and business environment that is relevant to the purpose of this paper. We divide the sample into 2 fundamentally different economic sectors -industrial and retail -and test the significance of each factor in the main relationship. We also examine the factor of the firm's ownership form by comparing earnings quality with investment efficiency values between public and private companies. Our main results show that a higher earnings quality mitigates both overinvestment and underinvestment issues. The relationship between earnings quality and underinvestment turns out to be stronger in the industrial sector. As for the comparison of public and private firms, public companies on average demonstrate a higher earnings quality and lower overinvestment issues.

Earnings management and corporate investment efficiency: does the board of directors matter?

“…In Eastern European countries, Cherkasova and Rasadi (2017) show that a higher earnings quality mitigates both overinvestment and underinvestment issues. Recently, Boubaker et al (2018) investigate the role of audit quality on corporate investment efficiency.…”

Free Cash Flow and Investment Efficiency of Listed Manufacturing Companies in Nigeria

“…Firms invest efficiently in a perfect market when they undertake all the investments that will result in positive net present value projects and discard those investments that will lead to harmful net present value projects. Though previous studies (e.g., Angela & Rilya, 2017;Chen, Hope, Li, & Wang, 2011;Cherkasova & Rasadi, 2017;Fakhroni et al, 2018;Guariglia & Yang, 2016;Nekhili, Fakhfakh, Amar, Chtioui, & Lakhal, 2016) suggest otherwise, this is as a result of the presence of market frictions. Thus, market frictions resulting in a clash of interest between shareholders, managers, and other stakeholders leads to agency conflict and asymmetric information.…”

“…An accounting-based model developed by Richardson (2006) was employed to measure IE. The model has been used severally by prior research in this area (Chen et al, 2011;Cherkasova & Rasadi, 2017;Moez & Amina, 2018). The model predicts the firm's IE, and the model's residuals were used as a proxy for inefficient investment.…”

“…Motivated by prior studies, several control variables were included in this study used in prior research as determinants of investment decisions (e.g., Chen et al, 2011;Cherkasova & Rasadi, 2017;Fusheng et al, 2015;Richardson, 2006). These control variables include; size, firm age, the level of cash, leverage, growth, cash flow from operations, tangibility, slack, past stock, lagged investment, and returns.…”

“…The concept of IE is well established in the literature of finance (Biddle et al, 2009;Chen et al, 2011;Cherkasova & Rasadi, 2017;Gao & Yu, 2018;Guariglia & Yang, 2016;Majeed et al, 2017;Mcdermott, 2012;McNichols & Stubben, 2008;Moez & Amina, 2018;Nekhili, Fakhfakh, Tawhid, et al, 2016;Richardson, 2006;Verdi, 2006). Researchers all over the globe have given a divergent opinion on IE.…”