The Real Effect of Financial Disclosure: International Evidence

Rajan and Zingales (1998, 2003) argue that good accounting standards and disclosure rules reduce the wedge between the cost of internal and external funds and enhance growth. We test the causal link between financial reporting and growth using a quasi-natural experiment – the mandatory adoption of International Financial Reporting Standards (IFRS) across the world - and examine its effect on innovation, a corporate activity that directly drives economic growth. Our Difference-in-Differences (DiD) results suggest that improved financial reporting leads to more innovation in the long run – it generates more patents and patents with higher impact. We also find that the positive effect of improved financial reporting on innovation is more pronounced among industries with higher dependence on external financing, consistent with the role of good financial reporting in reducing the cost of external financing. In addition, we find results consistent with the managerial learning hypothesis that managers are able to learn from the stock market after improved financial transparency. Our paper sheds new light on the real effects of financial reporting.