In this paper, we model earnings management as a consequence of the interaction among self‐interested economic agents ‐ namely, the managers, the shareholders, and the regulators. In our model, a manager controls a stochastic production technology and makes periodic accounting reports about his or her performance; an owner chooses a compensation contract to induce desirable managerial inputs and reporting choices by the manager; and a regulatory body selects and enforces accounting standards to achieve certain social objectives. We show that various economic trade‐offs give rise to endogenous earnings management. Specifically, the owner may reduce agency costs by designing a compensation contract that tolerates some earnings management because such a contract allocates the compensation risk more efficiently. The earnings‐management activity produces accounting reports that deviate from those prescribed by accounting standards. Given such reports, the valuation of the firm may be nonlinear and s‐shaped, thereby recognizing the manager's reporting incentives. We also explore policy implications, noting that (1) the regulator may find enforcing a zero‐tolerance policy ‐ no earnings management allowed ‐ economically undesirable; and (2) when selecting the optimal accounting standard, valuation concerns may conflict with stewardship concerns. We conclude that earnings management is better understood in a strategic context that involves various economic trade‐offs.

Two complementary sources of information are studied in a multiperiod agency model. One is an accounting source that partially but credibly conveys the agent's private information through accounting recognition. The other is an unverified communication by the agent (i.e., a self‐report). In a simple setting with no communication, alternative labor market frictions lead to alternative optimal recognition policies. When the agent is allowed to communicate his or her private information, accounting signals serve as a veracity check on the agent's self‐report. Finally, such communication sometimes makes delaying the recognition optimal. We see contracting and confirmatory roles of accounting as its comparative advantage. As a source of information, accounting is valuable because accounting reports are credible, comprehensive, and subject to careful and professional judgement. While other information sources may be more timely in providing valuation information about an entity, audited accounting information, when used in explicit or implicit contracts, ensures the accuracy of the reports from nonaccounting sources.

Two complementary sources of information are studied in a multiperiod agency model. One is an accounting source that partially but credibly conveys the agent's private information through accounting recognition. The other is an unverified communication by the agent (i.e., a self-report). In a simple setting with no communication, alternative labor market frictions lead to alternative optimal recognition policies. When the agent is allowed to communicate his or her private information, accounting signals serve as a veracity check on the agent's self-report. Finally, such communication sometimes makes delaying the recognition optimal. We see contracting and confirmatory roles of accounting as its comparative advantage. As a source of information, accounting is valuable because accounting reports are credible, comprehensive, and subject to careful and professional judgement. While other information sources may be more timely in providing valuation information about an entity, audited accounting information, when used in explicit or implicit contracts, ensures the accuracy of the reports from nonaccounting sources.

We consider partnerships among risk-averse professionals endowed with (i) a risky and personally-costly production technology and (ii) a personally-costly monitoring technology providing contractible noisy signals about partners’ productive efforts. Partners shirk both production and monitoring tasks because efforts are unobservable. We characterize optimal partnership size, profit shares and incentive payments when every partner performs the same tasks, and show that medium-sized partnerships are dominated by either smaller or larger partnerships. Prohibiting some partners from monitoring increases the incentives for others to monitor. We illustrate how task assignments and incentives interact, leading to improvements in partner welfare.

Faceless trading in a secondary stock market not only redistributes wealth among investors but also generates information that feeds back to real decisions. Using this observation we re‐evaluate the “leveling‐the‐playing‐field” rationale for disclosure to secondary stock markets. By partially preempting traders' information advantage established from information acquisition, disclosure reduces private incentives to acquire information, resulting in two opposite effects on firm value. On one hand, this narrows the information gap between informed and uninformed traders and improves liquidity of firm shares. On the other hand, this reduces the informational feedback from the stock market to real decisions. This tradeoff determines the optimal disclosure policy. The model explains why firm value can be higher in an environment that simultaneously promotes disclosure and private information production and why growth firms are endogenously more opaque than value firms.

In this paper, we investigate how the accounting measurement basis affects the capital market pricing of a firm's shares, which, in turn, affects the efficiency of the firm's investment decisions. We distinguish two broad bases for accounting measurements: input‐based and output‐based accounting. We argue that the structural difference in the two measurement bases leads to a systematic difference in the efficiency of the investment decisions. In particular, we show that an output‐based measure has a natural advantage in aligning investment incentives because of its comprehensiveness. The (first‐)best investment is achieved when the output‐based measure is noiseless and manipulation free. In addition, under an output‐based measure, more accounting noise/manipulation always leads to more inefficient investment choices. Therefore, if an output‐based accounting measure is highly noisy and easy to manipulate in practice, the induced investment efficiency can be quite low. On the other hand, an input‐based accounting measure, while not as comprehensive, may induce more efficient investment decisions than an output‐based measure if some noise is unavoidable in either measure. The reason is twofold. First, input‐based measures may be associated with less noise and limited manipulation in practice. Second, and more importantly, we show that under an input‐based measure, a slight increase in accounting noise/manipulation may lead to more efficient investment choices. In fact, the (first‐)best result is achieved when the noise/manipulability is small but positive. In other words, for an input‐based measure, being less comprehensive makes small but positive accounting noise/manipulability desirable. Two extensions of the basic model are also explored.

This paper studies the accounting treatment of uncertainty and how it affects a firm's capital structure. We distinguish two sources of uncertainty that raise reliability concerns: inherent uncertainty and incentive uncertainty. By inherent uncertainty, we refer to uncertainty about the quality of raw information regarding future cash flows. By incentive uncertainty, we refer to uncertainty about the quality of accounting numbers conveying the raw information. We explore features of accounting that can effectively deal with these two types of uncertainties in order to aid in the debt-equity decision of the firm. To handle inherent uncertainty, preferable accounting involves flexible revenue/expense recognition rules that recognize more profit when the uncertainty level is low. To deal with incentive uncertainty, a stringent revenue/expense recognition rule may be desirable to fend off management's opportunistic reporting behavior. Inflexible accounting rules cause a firm's financing choices to deviate from what would hold with complete information. Given any accounting rule, an information environment with a lower (higher) uncertainty regarding future cash inflows leads to higher (lower) expected debt financing. This is because assessed default risk is increasing in the uncertainty of future cash inflows, holding the uncertainty of the outflows constant.

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.

Views Icon Views Article contents Figures & tables Video Audio Supplementary Data Peer Review Share Icon Share Facebook Twitter LinkedIn Email Tools Icon Tools Get Permissions Search Site Cite View This Citation Add to Citation Manager Citation Chandra Kanodia, PIERRE JINGHONG LIANG; Accounting Disclosure and Real Effects. The Accounting Review 1 May 2010; 85 (3): 1119–1120. https://doi.org/10.2308/accr.2010.85.3.1119 Download citation file: Ris (Zotero) Reference Manager EasyBib Bookends Mendeley Papers EndNote RefWorks BibTex toolbar search Search Dropdown Menu toolbar search search input Search input auto suggest filter your search All ContentThe Accounting Review Search Advanced Search

In 1914, an accounting professor named Arthur Andersen founded a public accounting practice that became the world’s largest professional-services firm. For years preceding the Enron debacle and Andersen’s collapse, the firm had struggled to create incentives within the organization for partners to provide high-quality service, develop and sell new services, and meet the compensation expectations of various factions of partners. A years-long dispute over the division of profits between the firm’s consulting and accounting arms led to the 1998 separation of the consulting practice from the audit and tax practices. The rise, break-up and fall of Andersen underlines the importance of questions concerning incentive structures within public accounting firms in particular, and partnerships of professionals in general. This paper offers a perspective on partner compensation schemes and the accounting information systems that support them.