Optimal Comparability, Relative Accounting Performance, and Real Effects

44 Pages Posted: 24 Jun 2019 Last revised: 26 Feb 2020

See all articles by Sang Wu

Sang Wu

Carnegie Mellon University - David A. Tepper School of Business

Wenjie Xue

National University of Singapore

Date Written: August 2, 2019

Abstract

This paper examines how accounting comparability affects investment efficiency and risk-allocation in the economy. We develop the statistical and informational properties of accounting reports under varying degrees of comparability. In our information economics framework, a perfectly comparable accounting measurement system enables investors to perfectly infer the difference between any two firms' future cash flows although investors remain uncertain about either firm's cash flow. Because of the increased informativeness of the relative accounting performance, comparability alleviates the underinvestment problem by strengthening the price response to accounting earnings. However, perfect comparability is not socially optimal as it induces excessive price risk as well as systematic cash flow risk.

Keywords: accounting comparability, standard-setting, measurement error, asset price, cost of capital

JEL Classification: G12, G14, G18, M41, M48

Suggested Citation

Wu, Sang and Xue, Wenjie, Optimal Comparability, Relative Accounting Performance, and Real Effects (August 2, 2019). Available at SSRN: https://ssrn.com/abstract=3409454 or http://dx.doi.org/10.2139/ssrn.3409454

Sang Wu (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

Wenjie Xue

National University of Singapore ( email )

1E Kent Ridge Road
NUHS Tower Block Level 7
Singapore, 119228
Singapore

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