Financial Reporting Quality and Labor Investment Efficiency

Abstract

While similar arguments can be made about other, nonlabor investments (e.g., Biddle et al. 2009), an examination of labor is of particular interest in this context for two primary reasons. First, labor is an important factor of production, with labor costs typically representing roughly two-thirds of economy-wide value added (Hamermesh 1993;Bernanke 2004). For example, the U.S. Census Bureau's Annual Survey of Manufacturers reports that payroll and employee benefits in the manufacturing sector totaled $784 billion for 2008, compared to $166 billion in capital expenditures. 3 Clearly, labor investments are economically significant. Second, while evidence from prior research suggests that accounting quality improves the efficiency of capital expenditures by reducing financing frictions, it is not obvious that this result extends to labor. The adjustment costs associated with labor tend to be relatively low compared to capital expenditures (Dixit and Pindyck 1994), and traditional economic models have often treated labor as a variable factor of production. To the extent that labor costs are variable, they are paid out of current revenues and do not require financing (and by extension do not face the financing frictions that highquality accounting mitigates). Thus, whether high-quality accounting improves the efficiency of investments in labor is an open question.Despite the economic importance and distinguishing features of labor, prior literature (reviewed in section 2) relates financial reporting quality primarily to capital expenditures, without examining the effects on labor. The lack of attention to labor in this setting is noteworthy, particularly given that human capital is increasingly viewed as one of the most important factors for a firm's competitive success (e.g., Pfeffer 1996). This study addresses that gap in the literature.Our examination requires measures of both labor investment efficiency and accounting quality. We use firms' net hiring (percentage change in the number of employees) to proxy for investment in labor, and we create an inverse measure of investment efficiency using the absolute deviation of actual net hiring from its expected level. For our primary analyses, the expected level of net hiring is based on the model of Pinnuck and Lillis (2007), which includes economic variables that explain normal hiring practices, such as sales growth, liquidity, leverage, and profitability. Thus, our measure of abnormal net hiring captures the amount of net hiring not attributable to underlying economic factors. In sensitivity tests, we use the industry median to estimate expected net hiring and also consider several modifications of the baseline Pinnuck and Lillis model, including adding controls for labor power and for other concurrent investments.Our empirical proxies for financial reporting quality are drawn from prior literature. Our primary measure is based on a cross-sectional version of the Dechow and Dichev (2002) model, as modified by McNichols (2002) andSchipper (2005). In sensitivity tests,...

The Economics of Disclosure and Financial Reporting Regulation: Evidence and Suggestions for Future Research

“…The literature on the effects of reporting quality on corporate investment decisions is still in its early stages, but there are a number of studies suggesting that better reporting is associated with higher investment efficiency (e.g., Bens and Monahan [2004], Biddle and Hilary [2006], Bushman, Engel, and Smith [2006], Biddle, Hilary, and Verdi [2009], Cheng, Dhaliwal, and Zhang [2011], Badertscher, Shroff, and White [2013], Chen, Young, and Zhuang [2013], Goodman et al [2014]). Jung, Lee, and Weber [2014] examine effects on the efficiency of labor investments and document a positive association. There is also related work suggesting that financial misreporting by one firm can lead to inefficient investment decisions for competing firms.…”

“…[]). Jung, Lee, and Weber [] examine effects on the efficiency of labor investments and document a positive association. There is also related work suggesting that financial misreporting by one firm can lead to inefficient investment decisions for competing firms.…”

Corporate Social Responsibility Disclosure and the Value of Cash Holdings

“…Beatty & Liao, 2010;Biddle & Hilary, 2006;Biddle, Hilary, & Verdi, 2009;Bushman & Smith, 2001;Chen, Hope, & Li, 2011;Hope & Thomas, 2008;Jung, Lee, & Weber, 2014;Lambert, 2001;McNichols & Stubben, 2008). However, it is unknown how firms' non-financial reports, such as corporate social responsibility (CSR) reports, can be used by investors to monitor managers' use of corporate resources.…”

Employee Treatment, Labor Investment Efficiency and Firm Performance

“…In order to examine the relation between employee treatment and labor investment efficiency, we follow previous studies (Pinnuck and Lillis, 2007;Jung et al 2014) and use firms' net hiring (percentage change in the number of employees) to proxy for investment in labor. For our initial analyses, the expected level of net hiring is based on the model of Pinnuck and Lillis (2007), which includes economic variables that explain normal hiring practices such as sales growth, liquidity, leverage, and profitability.…”