The adoption of common accounting standards generates both a precision effect and a network effect. When firms use common standards, investors can leverage their knowledge about the standards to process more financial reports. Embedding both effects into the economic framework of Baiman and Verrecchia (1995, 1996), we study the adoption’s effects on reporting precision, firm value, and liquidity of both the switcher and the early adopter. The model helps address the identification challenge and reconcile some existing results in the empirical literature on IFRS adoption. It also generates implications for standardizing disclosure and accounting methods.

We study the role of reporting systems in the context of bank runs. In our model, a bank receives an early but imprecise estimate of its investment performance, and its financial reporting system generates a report. We find that, from a financial-stability standpoint, the optimal reporting system requires full disclosure when the bank’s early estimate is below a certain threshold, but no disclosure otherwise. Importantly, such optimal reporting threshold should be tailored to the bank’s exposure to bank-run risk. In particular, the threshold is nonmonotonic and U-shaped in the bank-run risk. We also relate our results to current accounting standards and discuss their implications for policy-making and empirical research.

We study firms' investment in internal controls to reduce accounting manipulation. We first show that peer managers' manipulation decisions are strategic complements: one manager manipulates more if he believes that reports of peer firms are more likely to be manipulated. As a result, one firm's investment in internal controls has a positive externality on peer firms. It reduces its own manager's manipulation, which, in turn, mitigates the manipulation pressure on managers at peer firms. Firms do not internalize this positive externality and, thus, underinvest in their internal controls over financial reporting. The problem of underinvestment provides one justification for regulatory intervention in firms' internal controls choices.

We propose a model to study how auditing standards affect audit quality. We posit that both auditors' incentives and expertise are relevant for audit effectiveness. Auditing standards are useful in mitigating the auditors' possible misalignment of interest with investors. However, auditing standards also restrict auditors' exercise of professional judgment, which, in turn, leads to compliance mentality and reduces auditors' incentives to become competent in the first place. We identify the conditions under which stricter auditing standards increase or decrease audit quality. Moreover, stricter auditing standards always increase audit fees, but can benefit auditors at firms' expense. The model also generates many testable empirical predictions.

In this paper, we analyze the social value of accounting objectivity in maintaining financial stability. Building on an early influential accounting study by Ijiri and Jaedicke (1966), we operationalize two informational properties, accuracy (free of collective bias) and objectivity (degree of consensus), in a correlated information structure and embed them into a model of runs on financial institutions. We show that when compared with the accuracy property, the objectivity property exhibits an advantage in mitigating inefficient panic-based runs. In fact, it is possible that improving objectivity discourages such runs, whereas improving accuracy encourages them. Our model also sheds light on the design of optimal accounting systems to enhance objectivity. We find that to generate a more objective accounting report, accounting systems should be designed to be less vulnerable to intentional managerial intervention.

We examine the impact of increasing whistleblowing bounties on whistleblowers' strategy and regulatory efficiency in detecting fraud. Our analysis shows the regulator extracts information about the incidence of fraud from whistleblowers' actions, and the quality of such information depends on the size of whistleblowing bounties. With a larger bounty, upon receiving a whistleblowing report, the quality of the regulator's information about fraud deteriorates, whereas upon observing no whistleblowing, the information quality about no fraud improves. Although the informational improvement upon no whistleblowing has not been widely discussed, we demonstrate it is a key determinant of the optimal whistleblowing program. We show, considering the informational value of whistleblowing and no whistleblowing, the regulator should set the bounty to encourage more whistleblowing when the prior belief of fraud is stronger and the insider is better informed. Our analysis generates policy and empirical implications for designing and studying whistleblowing programs.

We examine whether stress tests distort banks' risk‐taking decisions. We study a model in which a regulator may choose to rescue banks in the event of concurrent bank failures. Our analysis reveals a novel coordination role of stress tests. Disclosure of stress‐test results informs banks of the failure likelihood of other banks, which can reduce welfare by facilitating banks' coordination in risk‐taking. However, conducting stress tests also enables the regulator to more effectively intervene banks, coordinating them preemptively into taking lower risks. We find that, if the regulator has a strong incentive to bail out, stress tests improve welfare, whereas if the regulator's incentive to bail out is weak, stress tests impair welfare.

We study the economic impacts of adopting harmonized accounting standards when firms’ investments exhibit beauty contest features. We model harmonized accounting standards as common/correlated noises in firms’ accounting reports. We show that while more harmonized accounting standards have ambiguous effects on the reports’ informativeness in representing firms’ underlying fundamentals, they always reduce their usefulness in forecasting aggregate investments. Therefore, the stronger the beauty contest features, the more important the forecasts about the aggregate investment, thus calling for less harmonized accounting standards. We also find that, absent beauty contest features, mandatory adoption of harmonized accounting standards can be unnecessary; however, such a mandate is warranted when beauty contest features are strong as firms, when left on their own, would not voluntarily do so. Taken together, our results provide both a justification for and identification of an unintended consequence of the recent mandates toward adopting harmonized accounting standards.

Corporate managers are often better informed than outside investors about the uncertain future benefits of investments. However, information about investment prospects is not verifiable and therefore not amenable to direct disclosure, but instead inferred by investors from other accounting disclosures. Given this situation, we study the normative question of how the market’s perceptions of uncertainty and its beliefs about the expected level of future benefits of investment should factor into mandatory financial reports of investment expenditures. We establish a threshold of uncertainty in future benefits beyond which it is better to aggregate investment expenditures with cash flow from ongoing operations, rather than measuring and reporting the two separately. We obtain the surprising result that the higher the expectation of future benefits, the lower this uncertainty threshold should be.

This paper examines banks' choice between fair-value and historical-cost accounting when reported accounting information is used in capital requirement regulation. We center our analysis on a key difference between fair-value and historical-cost accounting: the frequency with which asset value changes are reported. We show that the elasticity of banks' loan returns to aggregate lending is a critical determinant of the interaction between capital adequacy requirements and accounting choices. If lending returns are inelastic, then higher capital requirements reduce fair-value usage. By contrast, higher capital requirements encourage fair value if capital requirements are low and lending returns are sufficiently elastic. In equilibrium, banks may elect different accounting choices, and we find that mandating uniform adoption of historical cost (fair value) is desirable when capital requirements are loose (tight). Our study offers many other implications about fundamental links between accounting and prudential choices.