An Examination of Direct and Spillover Effects of Accounting Standards on Firms’ Information Environments

Abstract

A growing literature suggests that accounting standards not only affect information at the public’s disposal but also improve the information environment within a firm leading to operational changes. In this paper, we examine a mechanism for the information improvements brought by accounting standards and their consequences. We present a model that demonstrates myopic incentives meant to induce managerial effort also can lead to underinvestment in information. However, imposing an accounting standard that mandates a minimum level of information quality can increase acquisition of decision-relevant information for activities the standard targets and untargeted but related activities. In this environment, the information acquisition also accentuates the myopic incentives to put forth effort. Collectively, the improvements in information quality and increase in effort that an accounting standard engenders have beneficial effects for the firm’s profitability. We examine the primary conclusions of the modeled environment using archival data in the context of the revenue recognition standard (ASC 606). We find evidence consistent with (i) myopic incentives being a key determinant of the positive information acquisition brought by accounting standards, (ii) improvements in information quality for the targeted activity (revenue) and a highly related activity (trade credit) but not a less related activity (uncertain tax planning), and (iii) increases in profitability that are correlated with investment in information necessary to comply with ASC 606.  

Keywords: accounting standards, ASC 606, information quality, managerial myopia, revenue recognition

JEL Classification: D80, M12, M41, M52