Does Disclosure of Non-Financial Statement Information Reduce Firms’ Propensity to Under-Invest?

Abstract

In the presence of information asymmetry, Myers and Majluf (1984) and Greenwald, Stiglitz, and Weiss (1984) demonstrate that a firm may pass up positive net present value (NPV) projects due to adverse selection in the equity market. The same model can be applied analogously in the debt market (Myers and Majluf, 1984). This study presents an empirical examination of whether disclosure of non-financial statement (NFS) information mitigates the under-investment problem, presumably by reducing information asymmetry between managers and potential stakeholders. I present three findings. First, I document that managers who provide more NFS information are less likely to under-invest. Second, by classifying NFS disclosures into those that are more relevant to equity holders and those more relevant to debt holders, I find that both types of disclosures are negatively associated with the degree of under-investment. Last, I provide evidence that both equity- and debt-related NFS disclosures are positively associated with the level of subsequent equity financing. These results hold after I use a two-stage least squares (2SLS) specification to control for the endogeneity between investment and disclosure and that between equity financing and disclosure.