On the Use of Instrumental Variables in Accounting Research

63 Pages Posted: 7 Apr 2005 Last revised: 13 Nov 2009

See all articles by David F. Larcker

David F. Larcker

Stanford University - Graduate School of Business; European Corporate Governance Institute (ECGI); Stanford University - Arthur & Toni Rembe Rock Center for Corporate Governance

Tjomme O. Rusticus

Hong Kong Polytechnic University - School of Accounting and Finance

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Date Written: May 16, 2008

Abstract

Instrumental variable (IV) methods are commonly used in accounting research (e.g., earnings management, corporate governance, executive compensation, and disclosure research) when the regressor variables are endogenous. While IV estimation is the standard textbook solution to mitigating endogeneity problems, the appropriateness of IV methods in typical accounting research settings is not obvious. Drawing on recent advances in statistics and econometrics, we identify conditions under which IV methods are preferred to OLS estimates and propose a series of tests for research studies employing IV methods. We illustrate these ideas by examining the relation between corporate disclosure and the cost of capital.

Keywords: Endogeneity, instrumental variables, disclosure, cost of capital

JEL Classification: C30, G30, M41, M43

Suggested Citation

Larcker, David F. and Rusticus, Tjomme O., On the Use of Instrumental Variables in Accounting Research (May 16, 2008). Available at SSRN: https://ssrn.com/abstract=694824 or http://dx.doi.org/10.2139/ssrn.694824

David F. Larcker

Stanford University - Graduate School of Business ( email )

Graduate School of Business
518 Memorial Way
Stanford, CA 94305-5015
United States
650-725-6159 (Phone)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Stanford University - Arthur & Toni Rembe Rock Center for Corporate Governance ( email )

Crown Quadrangle 559 Nathan Ab
Stanford, CA 94305-8610
United States

Tjomme O. Rusticus (Contact Author)

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

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