This study identifies several interrelated reasons why firms’ depreciation method choice is likely to influence managers’ capital investment decisions. We find that firms that use accelerated depreciation make significantly larger capital investments than firms that use straight-line depreciation. Further, we find that there has been a migration away from accelerated depreciation to straight-line depreciation over the past two decades. Firms that make such accounting changes make smaller capital investments in the post-change periods than in the pre-change periods. These results suggest that a choice made for external financial reporting purposes influences managers’ capital investment decisions.

Theory suggests that debt financing, relative to equity financing, makes managers reluctant to part with assets. Our evidence supports this theoretical prediction, revealing that the reluctance to part with a debt financed asset causes two decision errors—(1) participants forego investments that increase firm value and (2) participants accept investments that decrease firm value. When the source of finance is equity, participants are less likely to make either of these costly decision errors. Further, we find that higher unpaid principal accentuates participants' reluctance to part with debt financed assets. Finally, the decision errors stem, in part, from the perception that an asset having a large unpaid principal balance has provided lower past benefits than an otherwise identical asset.