Accounting comparability and relative performance evaluation by capital markets |
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| Institution: | 1. Columbia University, USA;2. National University of Singapore, Singapore;1. A.B. Freeman School of Business, Tulane University, USA;2. Lally School of Management, Rensselaer Polytechnic Institute, USA;1. Kenan-Flagler Business School, University of North Carolina at Chapel Hill, Campus Box 3490, McColl Building, Chapel Hill, NC 27599, USA;2. Ross School of Business, University of Michigan, 701 Tappan Avenue, Ann Arbor, MI 48109, USA;1. A. B. Freeman School of Business, Tulane University, New Orleans, LA 70118, USA;2. Argyros School of Business & Economics, Chapman University, Orange, CA 92866, USA;3. School of Business Administration, University of Dayton, Dayton, OH 45469, USA;1. Yale School of Management, Yale University, USA;2. BYU Marriott School of Business, Brigham Young University, USA;3. Lundquist College of Business, University of Oregon, USA;1. University of Miami Herbert School of Business, 5250 University Dr. Coral Gables, FL 33146, USA;2. University of Chicago Booth School of Business, 5807 S. Woodlawn Ave. Chicago, IL 60637, USA;3. Yale School of Management, 165 Whitney Ave. New Haven, CT 06511, USA |
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| Abstract: | This paper examines how accounting comparability affects the monitoring role and the risk allocation role of capital markets. We develop the statistical and informational properties of accounting reports under varying degrees of comparability. A perfectly comparable accounting information system enables investors to perfectly infer the difference between any two firms' future cash flows although investors remain uncertain about either firm's cash flow. Comparability alleviates entrepreneurs' moral hazard problem by strengthening the price response to the relative accounting performance, but can induce excessive price risk as well as residual systematic cash flow risk. Unlike the investors (users) who earn their surplus by bearing the residual systematic risk, the entrepreneurs (preparers) do not find perfect comparability desirable. Hence, a standard setter would mandate higher comparability than preferred by preparers, but not perfect comparability. |
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| Keywords: | Accounting comparability Standard setting Measurement error Information externality G12 G14 G18 M41 M48 |
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