Accounting Quality and Investment Efficiency in a Bank-Centered Economy: Evidence from the 2001 Bank Shareholding Limitation Act of Japan

Biddle and Hilary (2006) demonstrate that accounting quality improves investment efficiency in the U.S. but not in Japan. We examine whether no relation between accounting quality and investment efficiency remains valid in Japan beyond their study period, which ends in 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 in Japan after 2001. 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. This impact is more pronounced among firms with lower bank financing and lower cross-shareholdings.