Role of financial constraints and risk-taking on the relationship between financial reporting quality and investment efficiency: emerging and frontier markets’ perspective

Abstract

Purpose Prior evidence that financial reporting quality (FRQ) of publicly listed firms improves investment efficiency in developed markets leaves unaddressed questions of whether this relationship holds in emerging and frontier markets and what channels influence this relationship. This study aims to test the role of financial constraints faced by firms and managerial risk-taking on the association of FRQ and investment efficiency in 13,231 publicly listed firms in 24 emerging and frontier markets. Design/methodology/approach Available accounting data from 1998 to 2022 are collected for all listed firms across 41 industries in 24 countries. Causal relationships are tested using fixed-effect regression analysis, several additional tests and robustness checks are applied using alternative proxies and concerns for endogeneity are addressed using two-stage least square and system generalised method of moments analysis. Findings Findings show that FRQ of firms in emerging and frontier markets positively affects investment efficiency, the affirmative impact of FRQ on investment efficiency is higher when firms are facing more financial constraints and when managerial risk-taking is lower and financial constraints and risk-taking have a more pronounced impact on the link between FRQ and investment efficiency in the under-investment scenario. Originality/value These findings contribute to the growing body of evidence, shedding light on the meticulous interplay between FRQ and investment efficiency in frontier and emerging markets. Specifically, the increased financial constraints encountered by firms and a more conservative approach to managerial risk-taking emerge as crucial factors complementing this relationship.