We examine the effects of accounting standards and regulatory enforcement on entrepreneurial innovation and social welfare. When the entrepreneur issues a financial report that violates the accounting standards, a regulatory agency may detect the violation and bring charges. We find that when regulatory penalties are relatively insensitive to the magnitude of the violation, optimal standards are sufficiently low that they induce full compliance, and increase as the intensity of enforcement increases. In contrast, when regulatory penalties are sensitive to the magnitude of the violation, optimal standards induce non-compliance and decline as the intensity of enforcement increases.

We use newly available GAAP forecasts to document that traditionally-identified GAAP forecast errors contain 37% measurement error. Correcting for this measurement error, we settle a long-standing debate regarding investor preference for GAAP versus non-GAAP earnings and provide strong evidence of a preference for non-GAAP earnings. We also revisit the use of non-GAAP exclusions to meet analysts’ forecasts when GAAP earnings fall short. Results indicate that 34% of these traditionally-identified meet-or-beat firms are misidentified due to measurement error, and this error masks evidence that firms more frequently exclude transitory rather than recurring expenses for meet-or-beat purposes.