An Information-based Model for the Differential Treatment of Gains and Losses

43 Pages Posted: 22 Apr 2011 Last revised: 21 Jan 2018

See all articles by Venky Nagar

Venky Nagar

University of Michigan, Stephen M. Ross School of Business

Madhav V. Rajan

Booth School of Business, University of Chicago

Korok Ray

Texas A&M University - Mays Innovation Research Center

Date Written: January 7, 2018

Abstract

This study defines reporting conservatism as a higher verification standard for probable gains compared to losses and builds a model that endogenously generates optimal behavior resembling an asymmetric preference for gains versus losses. Our model considers the setting where one party produces a resource and another tries to expropriate it. The key factor determining the extent of the gain-loss asymmetry is the level of information asymmetry or trust between the two parties. The information asymmetry-based results of our model provide a simpler explanation for the vast empirical literature on conservatism where the bulk of the economic relationships among the parties appear to be information-based with little direct relation to explicit debt contracts, a factor that has been the focus of prior theoretical arguments. We also suggest new empirical analyses.

Keywords: Evolutionary economics, financial accounting, conservatism, prospect theory, game theory

JEL Classification: D00, M40, E11, C7

Suggested Citation

Nagar, Venky and Rajan, Madhav V. and Ray, Korok, An Information-based Model for the Differential Treatment of Gains and Losses (January 7, 2018). Review of Accounting Studies, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1815794 or http://dx.doi.org/10.2139/ssrn.1815794

Venky Nagar

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
734-647-3292 (Phone)
734-764-3146 (Fax)

Madhav V. Rajan

Booth School of Business, University of Chicago

1101 East 58th Street
Chicago, IL 60637-1561
United States

Korok Ray (Contact Author)

Texas A&M University - Mays Innovation Research Center ( email )

4113 TAMU College State
TX 77843-4113
United States

HOME PAGE: http://mays.tamu.edu/directory/korok/

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