Imprecision in Accounting Measurement: Can it Be Value Enhancing?

Abstract

Accounting measurements of firms' investments are usually imprecise. We study the economic consequences of such imprecision in a setting where accounting imprecision interacts with information asymmetry regarding the ex ante profitability of the project that is privately known by the firm's managers. Absent agency and risk sharing considerations, we find that some degree of accounting imprecision could actually be value enhancing. We characterize the optimal degree of imprecision and identify its key determinants. The greater the information asymmetry about the project's profitability, the greater is the imprecision that should be tolerated in the measurement of the firm's investment.

Keywords: Noisy signaling, Accounting Imprecision, Investment incentives

JEL Classification: D82, G31, L10, M41