Accounting Quality and the Transmission of Monetary Policy

We examine how firms’ accounting quality affects their reaction to monetary policy. The balance sheet channel of monetary transmission emphasizes the role of information asymmetry between firms and capital providers in propagating the effects of monetary policy. Building on this theory, we argue that the quality of firms’ accounting reports can play an important role in transmitting monetary policy by affecting information asymmetry between firms and capital providers. Consistent with this argument, we find that firms with lower accounting quality have a larger equity market response and future investment that is more sensitive to unexpected changes in monetary policy. Moreover, the relation between firms’ equity market responses to monetary policy and their accounting quality is greater for firms with more growth opportunities and firms that are more financially constrained, further consistent with the predictions of the balance sheet channel of monetary transmission.