We investigate the extent to which income measurement by major early 20th‐century U.S. railroads shows evidence of lower income smoothness and increased conservatism following new fixed asset accounting rules issued by the Interstate Commerce Commission (ICC) in 1907 and 1908 and concurrent rate regulation regime shifts. Accounting rules promulgated by the ICC after the Hepburn Act of 1906 are the first accounting rules in U.S. history in which regulators could enforce such rules under federal law to increase compliance. Our samplewide results are more consistent with increased conservatism than with income smoothing. Additional tests indicate these effects are more pronounced for firms subject to more intense rate regulation by the ICC, which suggests that the tie‐in between accounting regulation and product/service market regulation influences how managers respond to new accounting rules.

Scholars have long suspected that people behave differently when their actions will be observed by or revealed to others. We hypothesize that financial reporting that reveals managers' actions will lead managers to take actions that better align with investor interests. We test this hypothesis with an experiment in which we manipulate the availability of a financial report that reveals managerial actions. Our evidence shows that financial reporting leads a manager to choose reinvestment and resource-sharing actions that better align with investor interests, even when the investor can impose no cost or confer no reward on the manager. This effect holds when the investor can shut down the firm and take a sizable portion of the assets. Our evidence suggests that financial reporting's economic value comes not only from its traditional contracting function, but also because managers care about investors' moral evaluations of them that are enabled by reporting.