Asymmetric Cycles and Asymmetric Accounting

Abstract

This study investigates how asymmetric accounting influences aggregate investment efficiency over boom–bust business cycles. Accounting asymmetry can be downward (conservative accounting) or upward (liberal accounting), with accounting symmetry (neutral accounting) as a special case. We find that neither symmetry nor upward asymmetry resolves the problem of aggregate underinvestment during booms, while extreme downward asymmetry creates a problem of aggregate overinvestment during busts. There exists a unique degree of downward asymmetry that maximizes aggregate investment efficiency. This efficiency-maximizing asymmetry varies with accounting and economic factors, such as quality of accounting system before introducing asymmetry, sensitivity of firms’ investment projects to state of the economy, and volatility of state. Our analysis highlights asymmetric accounting as a novel policy tool in macroeconomic management and as an additional consideration in the debate over neutrality versus conservatism in conceptual frameworks for financial reporting.

JEL Classification: E32, M41, M48