The Effect of Uncertainty about Future Accounting Standards on Financial Reporting Quality

Abstract

Financial statement preparers often make estimates with uncertainty about the requirements of future accounting standards. Prior theory and empirical research provide evidence that individuals and organizations respond to changing economic incentives caused by such policy uncertainty. Results of our experiment document two novel behavioral effects of policy uncertainty on preparers’ estimates. First, uncertainty causes preparers to make less biased estimates even though, in our setting, reduced bias is not in preparers’ financial interest. Second, uncertainty increases preparers’ sensitivity to measurement imprecision, which is important for high quality financial reporting. These findings suggest that policy uncertainty improves preparers’ decision processes in ways that go beyond a rational response to incentives. Although uncertainty in standard setting is often criticized, our theory and results suggest that increased financial reporting quality can be an unanticipated benefit of the uncertainty that naturally arises from a measured and deliberative standard setting process.

Keywords: accounting standards, financial reporting quality, accounting estimates, experimental economics

JEL Classification: D81, M41