Capital Allocation Effects of Financial Reporting Regulation and Enforcement
Posted: 14 Nov 2010 Last revised: 14 Nov 2012
Date Written: November 12, 2010
This paper analyses the effects of stricter financial reporting enforcement on capital allocation and reporting quality in a game-theoretic model and derives conclusions about optimal enforcement strictness. Analysis of the model shows that reporting quality strictly increases with tighter enforcement. However, the effect of stricter enforcement on capital allocation is non-monotonic. Intermediate enforcement strictness results in overdeterrence of viable projects even without costs of compliance. This effect can be alleviated by means of either less or more stringent enforcement.
Keywords: accounting regulation, enforcement, earnings management, earnings quality, capital allocation, analytical accounting
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