Disclosure Quality and Capital Investment

We examine whether disclosure quality affects the link between a firm’s cash flow or asset values and its capital investment. We use a unique setting to examine this issue: a sudden 50% decrease in oil prices in 1986. This setting allows us to examine the effect of disclosure quality immediately prior to an unexpected, exogenous increase in a firm’s capital constraint on the firm’s capital investment immediately following the shock. In contrast to prior research, which examines the association between the level of disclosure and the level of a firm financing attribute (e.g., cost of public equity capital), we examine how the level of disclosure affects the change in firm investment. We find that high quality disclosure mitigates the effect of the oil price shock on investment. In addition, firms that are more capital constrained get a larger benefit from better disclosure, and high disclosure firms have a smaller reduction in long-term external capital following the price shock.