Higher-quality accounting information results in better resource allocation within industries, Yue Zheng from HKUST and her coauthors have established. Access to accurate accounting data reduces “friction” in information flows, providing external parties with a complete picture of productivity that can improve investment decisions.

Productivity measures how efficient companies are in transforming inputs into outputs. “Productivity is an important dimension of a well-functioning market,” explain the researchers, “especially within the manufacturing sector.” However, measuring a firm’s productivity is challenging, particularly for external market participants that “do not have perfect information about the underlying distribution of firm productivity.” The authors suggest that a lack of accurate data causes “information frictions,” which in turn result in suboptimal resource allocation.

To test this argument empirically, the team examined data from over 4,500 US manufacturing firms in 50 narrowly defined industries over 25 years to track the impact of information frictions on productivity. Using the widely accepted total factor productivity measure, the team identified “evidence of large and persistent productivity dispersion” across firms within an industry—in some cases as large as 45%.

The researchers mainly adopt two financial reporting quality measures that capture the extent to which accounting information is informative about firm productivity: (1) asset informativeness, which captures degree to which accounting assets represent an informative measure of economic capital; (2) asset-turnover quality, which is based on the reliability of the reported asset turnover ratio. As expected, the researchers report, “industries with higher productivity informativeness tended to have smaller within-industry productivity dispersion.” But why?

Access to high-quality financial data works to “facilitate more efficient resource allocation and reduce productivity dispersion,” explain the authors. Although this principle is not new, this is the first time that scholars have tested the relationship across firms within industry. Zheng and colleagues found that the relationship was stronger in industries with greater dependence on external financing, “suggesting that reporting quality affects allocation efficiency at least in part through the capital market channel.”

The paper’s success in establishing a link between accounting information quality and productivity within different industries has important implications for both academia and the real economy. The findings indicate “a specific role of accounting information, namely to inform investors about firm productivity,” say the authors. “Improving financial reporting quality can reduce [information] frictions and in turn productivity dispersion.”