The Effect of Financial Disclosure on Mutual Fund Investment Decisions: Evidence from an Information Shock

This paper investigates how the quality of financial disclosures impacts the portfolio choices of domestic and foreign investment companies. I implement an exogenous shock to the quality of financial reporting in European equity markets and examine the portfolio choices of global mutual funds in the pre and post periods. I find that when investing in the European equity market, non-European mutual funds significantly improve their stock-picking skills after the shock, in contrast to domestic ones whose skills deteriorate afterward. Besides, non-European mutual funds also increased their investments in the European market. The change in the portfolio choices between domestic and foreign investment companies is more profound in stocks with larger information asymmetry, proxied by return and earnings volatility. My results contribute to the positive accounting theory by showing that the aggregated information in financial disclosure could help investors make better investment decisions. However, to improve the disclosure quality may not make all investors better off. Instead, the role financial reporting serves is to level the playing field between different groups of investors