You Don’t Know What You Don’t Know: Improvements in Investment Efficiency Prior to a Mandated Accounting Change

Abstract

Theory suggests mandated changes in accounting standards can lead to increases in investment efficiency through two mechanisms: (1) increases in internal information quality (IIQ), or (2) reductions in information asymmetry with external parties. We use the long transition period of the new lease accounting standard to isolate the effects of increases in IIQ on investment efficiency. Using a difference-in-differences design we find that firms affected by the new lease standard experience significant increases in investment efficiency in the year immediately preceding the standards implementation. The improvements in investment efficiency are largest for firms with high lease intensity and multiple operating segments. The increases in investment efficiency are driven by over-investing firms that reduce their capital expenditures and net acquisitions. We contribute to the investment efficiency literature by identifying the effect of IIQ on investment behavior. Further, we document that internal information gathering in anticipation of a new accounting standard can improve managerial decision-making, an explicit goal of the FASB’s post-implementation review of the lease standard.