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| Author: | Larcker, D.F. Rusticus, T.O. |
| Title: | On the use of instrumental variables in accounting research |
| Journal: | Journal of Accounting & Economics
2010 : APR, VOL. 49:3, p. 186-205 |
| Index terms: | endogenous variables disclosure capital costs method study regression analysis |
| Language: | eng |
| Abstract: | Instrumental variable (hereafter as: IV) methods are often used in accounting research, e.g. earnings management, corporate governance, executive compensation, and disclosure research when the regressor variables are endogenous. IV estimation is the standard textbook solution to mitigating endogeneity problems, but the appropriateness of IV methods in typical accounting research is not self-evident. This study draws on recent advances in statistics and econometrics, identifying conditions under which IV methods are preferred to OLS estimates. It proposes a series of tests for research studies employing IV methods. The ideas are illustrated by examining the relation between corporate disclosure and the cost of capital. The results and numerical simulations indicate that when the instrument is only weakly correlated with the regressor, IV methods can produce highly biased estimates when the instrumental is even slightly endogenous. |
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