Real Effects of Uniformity in Accounting Measurement: A Common Understanding

Abstract

We theoretically and experimentally investigate the effect of uniformity in accounting measurement on value enhancing coordination in the presence of strategic uncertainty. We use a setting where two agents have differential information due to non-uniform accounting structures about the gains from coordinated investment, and derive equilibrium predictions that coordination is expected to occur when each agent's behavior relies only upon their own beliefs of the fundamental uncertainty, while higher-order iterative reasoning of beliefs prevents coordination and wealth creation. Our experimental design allows us to control for various behavioral phenomena and examine participants' decisions across different accounting regimes as to isolate the coordination effect of strategic uncertainty resulting from non-uniform accounting measurement. Our results suggest that when both fundamental and strategic uncertainty arises from non-uniform accounting measurement, participants behave as if they exercise higher-order iterative reasoning, albeit only to a limited degree, that can potentially cause breakdown of welfare enhancing coordination. Therefore, not only the information, but also the shared understanding of the information, can affect wealth creation. These results can offer insight into when more uniform measurement rules are desirable.

Note: An earlier version of this paper was titled "Higher-Order Beliefs in Simple Trading Models".

Keywords: information asymmetry, experiment, strategic uncertainty, higher-order beliefs, iterative reasoning

JEL Classification: C72, C91, D82, D83