Accounting Comparability, Financial Reporting Quality, and the Pricing of Accruals

Abstract

This study examines the impact of accounting comparability on financial reporting quality and the extent to which financial statement users understand the implications of firms’ accruals. We predict that comparability improves the information environment, which not only enhances the ability of managers to estimate accruals more accurately and signal their private information, but also improves investors’ comprehension of accruals. Utilizing restatements, the mapping of accruals into cash flows, earnings persistence, and audit fees as measures of financial reporting quality, we find that prior-period comparability is associated with higher financial reporting quality. We also provide evidence that comparability is positively associated with managerial forecast accuracy and precision, consistent with comparability improving the ability of managers to predict future firm performance. Furthermore, we find that when prior-period comparability is higher, current period discretionary accruals are less positively correlated with contemporaneous returns and less negatively correlated with future returns, consistent with our prediction that comparability improves the pricing efficiency of accruals. Our results are robust to controlling for the endogeneity of accounting comparability and several different empirical model specifications. Overall, our findings suggest that enhanced accounting comparability is beneficial to both preparers and users of financial statements.

Keywords: Comparability, Financial Reporting Quality, Accrual Mispricing, Earnings, Market Efficiency

JEL Classification: G14, M41