Consistency As A Means to Comparability: Theory and Evidence
45 Pages Posted: 25 Oct 2016 Last revised: 22 Dec 2020
Date Written: December 21, 2020
This paper studies financial statement consistency--the purported means to comparability--from an information perspective. We model consistency as firms' required propensity to apply common accounting methods to individual transactions, and show that consistency creates information spillover through correlated measurements ("spillover channel") while potentially reducing the informativeness of one's own report ("standalone channel"). The model generates two central predictions. First, optimal consistency decreases with a transaction's fundamental correlation as high correlation diminishes information gains via the spillover channel. Second, optimal consistency decreases with a transaction's fundamental volatility as high volatility exacerbates information losses via the standalone channel. Empirical evidence supports both predictions. Overall, this paper contributes a framework for studying comparability and draws useful policy implications.
Keywords: Financial Statement Consistency; Comparability; Informativeness; Information Spillover; Fundamental Correlation; Fundamental Volatility
JEL Classification: G14; G18; M40; M41; M48
Suggested Citation: Suggested Citation