Commonality of Accounting Standards and Investment Beauty Contests
55 Pages Posted: 8 Jan 2021 Last revised: 11 Jun 2021
Date Written: June 8, 2020
We study the optimal level of commonality of accounting standards when firms' investments exhibit beauty-contest features as in, e.g., Arya and Mittendorf (2016). We model more commonality of accounting standards as more correlated noises in firms' reports, consistent with the "more harmonized" accounting standards notion in Barth et al. (1999). We show that while more common accounting standards have ambiguous effects on the reports' informativeness in representing firms' underlying fundamentals, they always reduce the reports' precision in forecasting firms' aggregate investment. The stronger the beauty-contest features, the more important the forecasts about the aggregate investment, and thus the less common the standards should be. We also find that, absent beauty-contest features, mandatory adoption of more common accounting standards can be unnecessary; however, such mandate is warranted when beauty-contest features are strong as firms, when left on their own, would adopt even less common standards. Taken together, our results both provide a justification for and identify an unintended consequence of the recent mandates towards adoption of more common accounting standards.
Keywords: Beauty Contest, Investment Externality, Information Spillover, Disclosure, Accounting Standards, Harmonization, IFRS Adoption
JEL Classification: M41, M48
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