Property rights, investments, and financial reporting quality: Evidence from a natural experiment

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Allen Huang

In this project, we aim to investigate whether and how an increase in property rights in China affects two constructs of key importance to emerging markets, i.e., investment efficiency and financial reporting quality, through a relaxation of credit constraints. Superior property rights generally lead to an improvement in access to financing. We focus on investment efficiency and financial reporting quality as outcome variables because of their importance for emerging markets. For example, Jun [2003] finds that the high growth in China between 1978 and 2000 could largely be attributed to the increase in investment efficiency of small firms in rural areas. Moreover, Bhattacharya, Daouk, and Welker [2003] show that lower earnings opacity (i.e., higher financial reporting quality) is regarded with a lower cost of equity. Similarly, Bharath, Sunder, and Sunder [2008] provide evidence that firms with higher financial reporting quality are able to access financing from a broader set of lenders and also face less stringent loan contract terms. We position our study at an appropriate intersection of the law, finance, and accounting literatures with a specific emphasis on emerging-market-type firms. Our study identifies property rights as a specific mechanism that drives our results. In summary, we aim to examine the effect of property rights on firms’ investment efficiency and financial reporting quality via the access to financing. In the next section, we outline our main hypotheses.

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