Accounting Conservatism, Aggregation, and Information Quality

19 Pages Posted: 4 Dec 2007 Last revised: 2 Jul 2015

See all articles by Qintao Fan

Qintao Fan

University of Oregon, Lundquist School of Business

Xiao-Jun Zhang

University of California, Berkeley; China Academy of Financial Research (CAFR)

Date Written: November 1, 2007

Abstract

We study the optimal accounting policy when a firm can control the information quality through costly and noncontractible action. It is shown that the desirable accounting has two features: (i) the accounting report aggregates, rather than reporting directly, the underlying information; (ii) the accounting has a conservative bias. By invoking the conservatism principle, which serves as a commitment to an apparently inefficient accounting scheme given the ex post information quality, firms are induced to spend more effort in controlling information quality ex ante. As a result, a biased accounting system improves the overall information quality and enhances the welfare of accounting information users. In equilibrium the information users' welfare decreases with a firm's private cost of information quality control and increases with a firm's benefits from favorable accounting reports.

Keywords: Accounting Conservatism, Information Aggregation, Information Quality

JEL Classification: M41, M44

Suggested Citation

Fan, Qintao and Zhang, Xiao-Jun, Accounting Conservatism, Aggregation, and Information Quality (November 1, 2007). Available at SSRN: https://ssrn.com/abstract=1050521 or http://dx.doi.org/10.2139/ssrn.1050521

Qintao Fan (Contact Author)

University of Oregon, Lundquist School of Business ( email )

Lillis Business Complex
#374
Eugene, OR 97403
United States
5143464865 (Phone)

Xiao-Jun Zhang

University of California, Berkeley ( email )

545 Student Services Building
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Berkeley, CA 94720
United States
(510) 642-4789 (Phone)
(510) 642-4700 (Fax)

China Academy of Financial Research (CAFR)

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Shanghai P.R.China, 200030
China

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