The impact of accounting quality on investment efficiency: Evidence from the 2001 bank shareholding limitation act of Japan

Biddle and Hilary (2006) demonstrate that accounting quality plays an important role in improving investment efficiency in the United States but not in Japan. We examine whether the role of accounting quality remains insignificant in Japan beyond their study period, 1975–2001. We hypothesize that since Japan experienced a dramatic decline in bank financing and keiretsu affiliations after 2001, when the Act on Limitation on Shareholding by Banks and Other Financial Institutions became effective, accounting quality became positively related to investment efficiency. Consistent with our hypothesis, we find a positive impact of accounting quality on investment efficiency in the post-2001 period. We also find that higher accounting quality improves investment efficiency by reducing the tendency of over-investment. The positive impact of accounting quality on investment efficiency is more pronounced among firms with lower bank financing and lower cross-shareholdings.