Accounting Policy Similarity and Active vs. Passive Institutional Investors

Abstract

I examine the differential effects of similarity in accounting policy disclosures by firms on investment by active and passive institutional investors. I develop a novel measure of accounting similarity based on the textual disclosure of firms’ accounting policies from their annual reports. I find that, among firms with less similar textual descriptions of their accounting policies, investment by active institutions is higher than that of passive institutional investors. This suggests that these investors have a real or perceived information advantage in investing in firms with less comparable accounting. To establish causality, I use a difference-in differences approach that relies on the plausibly exogenous introduction of an accounting rule change, which is likely to decrease accounting similarity, and the rule’s subsequent reversal. My paper offers novel evidence on an under-explored relation between the textual properties of accounting disclosures and investor preferences.