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

Abstract

When making estimates in the current period, financial statement preparers often face uncertainty about the requirements of accounting standards in future periods. Prior theoretical and empirical research provides 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, policy uncertainty causes preparers to make less biased estimates even though, in our setting, reduced bias is inconsistent with preparers’ financial interest. Second, policy uncertainty increases preparers’ sensitivity to measurement imprecision, which is important for high quality financial reporting. These findings suggest that uncertainty about future accounting standards improves preparers’ decision processes in ways that go beyond a rational response to incentives. Although policy uncertainty in standard setting is often criticized, our theory and results suggest that increased financial reporting quality can be an unanticipated benefit of the policy 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