Financial Reporting Quality and Labor Investment Efficiency

We examine whether accounting quality is associated with efficient investments in labor, a key factor of production that has been largely overlooked in prior studies. We find evidence that abnormal net hiring (measured as the absolute deviation from net hiring predicted by economic fundamentals) is negatively associated with accounting quality. These results are robust to a battery of sensitivity tests and controls for other relevant factors, including labor power and other contemporaneous investments. We further examine the channels through which accounting quality improves net hiring efficiency and provide evidence that high-quality accounting reduces both overinvestment in labor (overhiring and underfiring) and underinvestment in labor (underhiring and overfiring). We also show that the effect of accounting quality on net hiring efficiency is particularly strong in highly unionized industries. Finally, we document that abnormal net hiring is costly, in that it is associated with lower future profitability. Overall, our results are consistent with higher-quality accounting facilitating more efficient investments in labor by mitigating the market frictions that stem from information asymmetry and lead to suboptimal levels of investment.