The Allocational Effects of the Precision of Accounting Estimates

Journal of Accounting Research, Vol. 45, No. 4, pp. 731-769, September 2007

39 Pages Posted: 11 Dec 2007

Abstract

Finally, we show that, in a setting where the firm's initial owner sells his stake in the firm over the course of two periods, with disclosures of estimates of the firm's value occurring prior to each sale of shares, if the precisions of the estimates are public, the equilibrium precisions of the estimates increase over time when the owner sells a sufficiently large fraction of the firm in the first period, and otherwise the equilibrium precisions of estimates remain constant over time. In a multifirm version of the model with endogenous investment, we show that the equilibrium investment by the firm increases in the precision of the firm's own estimate and decreases in the precisions of other firms' estimates. This paper studies the allocational effects associated with the precision of accounting estimates when the precision of estimates is a choice variable for firms. One part of the paper considers the effects of the observability of precision choices. We show that, generally, making precision choices private increases firms' equilibrium precision choices and also, as a by-product, their equilibrium investment choices. We further show that, when firms' precision choices are private, there may be a disclosure trap, in which, unless investors conjecture the owner has chosen an estimate with the highest possible precision, the owner will respond to investors' conjecture by choosing an estimate whose precision is higher than investors' conjecture. In a multifirm version of the model with endogenous investment, we show that the equilibrium investment by the firm increases in the precision of the firm's own estimate and decreases in the precisions of other firms' estimates. Finally, we show that, in a setting where the firm's initial owner sells his stake in the firm over the course of two periods, with disclosures of estimates of the firm's value occurring prior to each sale of shares, if the precisions of the estimates are public, the equilibrium precisions of the estimates increase over time when the owner sells a sufficiently large fraction of the firm in the first period, and otherwise the equilibrium precisions of estimates remain constant over time.

JEL Classification: G12, M41, M45, G31, G32

Suggested Citation

Dye, Ronald A. and Sridharan, Swaminathan, The Allocational Effects of the Precision of Accounting Estimates. Journal of Accounting Research, Vol. 45, No. 4, pp. 731-769, September 2007, Available at SSRN: https://ssrn.com/abstract=1065882 or http://dx.doi.org/10.1111/j.1475-679X.2007.00249.x

Ronald A. Dye (Contact Author)

Northwestern University - Department of Accounting Information & Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-2663 (Phone)
847-467-1202 (Fax)

Swaminathan Sridharan

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-8807 (Phone)
847-467-1202 (Fax)

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