We examine how outsiders rationally interpret a reported loss on derivatives when the application of mark‐to‐market accounting to cash flow hedges creates a mixed attribute problem. We find that because of the mixed attribute problem, the information content of mark‐to‐market accounting is related to the information content of historical cost accounting in a very specific way. This relationship allows us to identify the circumstances under which mark‐to‐market accounting facilitates and when it detracts from the objective of providing an early warning of potential financial distress. We show that the reporting of an impending derivative loss by a distressed firm can actually lead outsiders to infer that the firm is in a better financial position than what they would have inferred under the silence associated with historical cost accounting. Without the mixed attribute problem, mark‐to‐market accounting would always yield more accurate assessments of the firm's financial position.

We investigate whether a firm's intangible investments should be measured and separated from operating expenses. We find that the information extracted from accounting reports of investments and earnings is different when intangibles are measured and identified separately from operating expenses than when intangibles are left commingled with operating expenses. This difference in the market's information causes a change in the behavior of market prices, inducing changes in the firm's investments and cash flows. Thus, from a real effects perspective, measuring intangibles is not unambiguously desirable. We identify the conditions under which providing information on intangibles may be desirable. This study also shows the inadequacy of statistical associations between accounting numbers and prices as a basis for evaluating the desirability of measuring intangible investments. We show that the measurement of intangibles alters the very distribution of cash flows about which the measurement regime is seeking to provide information.

Corporate managers often express concern about accounting-induced volatility in financial statements. Accounting regulators, however, argue that the volatility in financial statements merely increases transparency by shining a light on risks that are inherent to the firm’s business. We show that in many situations managerial concerns about volatility are justified because the information that is being provided actually magnifies rather than merely reflects the volatility in a firm’s fundamentals. Corporate managers anticipate the magnified volatility and take preemptive actions to decrease the firm’s exposure to the accounting treatment that induces volatility. These actions may not be in the best interests of external stakeholders, making disclosure costly, while at the same time improving the decisions of external stakeholders. We develop and study the resultant tradeoff that accounting regulators should consider in setting accounting standards.

We develop a cost–benefit tradeoff that provides new insights into the frequency with which firms should be required to report the results of their operations to the capital market. The benefit to increasing the frequency of financial reporting is that it causes market prices to better deter investments in negative net present value projects. The cost of increased frequency is that it increases the probability of inducing managerial short‐termism. We analyze the tradeoff between these costs and benefits and develop conditions under which greater reporting frequency is desirable and conditions under which it is not.

In this paper we examine how accounting conservatism affects the efficiency of debt contracting. We develop the statistical and informational properties of accounting reports under varying degrees of conditional and unconditional accounting conservatism, consistent with Basu's [1997] description of differential verifiability standards. Optimal debt covenants and interest rates on debt are derived from a natural tension between debt holders and equity claimants. We show how optimal covenants vary with the degree of conservatism and derive an efficiency metric that depends on the degree of conservatism. We find that accounting conservatism actually decreases the efficiency of debt contracts, contrary to the suggestions of Watts [2003] and contrary to the hypothesis in numerous empirical studies.

Chandra Kanodia, Arijit Mukherji, Haresh Sapra, Raghu Venugopalan, Hedge Disclosures, Future Prices, and Production Distortions, Journal of Accounting Research, Vol. 38, Supplement: Studies on Accounting Information and the Economics of the Firm (2000), pp. 53-82