Cash Flow Forecasts and Corporate Investment – Evidence from a Natural Experiment

Description

A fundamentally important question in accounting is how accounting information affects investment. Several prior studies have examined whether accounting information constrains managers’ suboptimal investment behaviors (e.g., Hope and Thomas 2008; Francis and Martin 2010; Bushman, Piotroski, and Smith 2011). In a recent review paper, Roychowdhury, Shroff, and Verdi (2019) conclude that “the literature has provided reasonably consistent evidence of a negative relation between reporting quality and over-investment.” They further suggest that “opportunities exist to distinguish between specific aspects and types of reporting and disclosure choices. For example, are forwardlooking versus backward-looking disclosures more relevant for constraining moral hazard?” The primary objective of this research is to contribute to this literature by examining whether corporate investment is affected by cash flow forecasts. We focus on cash flow forecasts because the trend towards using fair values in financial reporting increasingly requires managers to estimate future cash flows. We will exploit a natural experiment of a disclosure regulatory change that offers plausibly exogenous variation in cash flow forecasts. A Canadian security issuer that produces minerals and metals had been required to provide cash flow forecasts in its technical reports as mandated by the National Instrument 43-101 Standards of Disclosure of Mineral Projects. We consider an amendment to this regulation that exempted certain firms from providing these forecasts. This setting is powerful for addressing the research question because it enables us to examine the change in corporate investment between firms that were exempted from the disclosure requirement and those that remained required to provide this disclosure in a difference-indifferences framework. We argue that these cash flow forecasts are useful for monitoring investment because they are timely, relevant for determining project value, and appear to be accurate ex post. If the disclosure exemption leads to worse monitoring, then we would expect exempted firms to engage in more suboptimal investment after the amendment compared with firms that were not exempted. We consider both fixed assets investment and acquisition quality. We will also examine change in long-term performance, a consequence of investment quality.