Accounting Measurement Intensity

Abstract

Measurement is a ubiquitous component of markets and organizations. Despite its central place in the theory of the firm, the effect of measurement practices on firms' decisions and economic outcomes is not well-understood. We characterize companies by the intensity of their measurement practices to convert economic transactions into numbers reported in financial statements. In particular, we develop an algorithm that uses textual patterns to uniquely identify the application of measurement rules in firms' annual reports and construct firm-level scores of measurement intensity. We hypothesize that measurement-intensive firms are more likely to suffer from distortions when providing managerial incentives. We test theoretical predictions that link measurement intensity to firms' investment decisions, productivity, and the design of incentive
schemes. In line with these predictions, we find that more measurement-intensive firms exhibit lower levels of investment and hiring, lower total factor productivity and Tobin's Q, and attenuated the pay-performance sensitivity of CEO compensation contracts. Together, these findings are consistent with the predictions in Alchian and Demsetz (1972) that measurement problems are central to explaining firms' boundaries and contracting.

Keywords: measurement, metering problem, theory of the firm, productivity, investment

JEL Classification: D22, D23, D24, G12, J23, M40