Information Externalities and Accounting Standardization

Abstract

Firms' information disclosure is a public good: When firm fundamentals are correlated, one firm's information can benefit others in making better decisions. Without regulation, firms fail to internalize the benefits of their disclosure and underproduce information. To address this, firms may resort to integration (become devisions of a combined firm and let the headquarters set the level of information production) or accounting standardization (remain independent and let the regulator set a uniform information production level). We find that integration's flexibility enhances investment efficiency ex post, but also leads divisions to overinvest ex ante. Accounting standardization can curb free-riding incentives and improve investment efficiency. Overall, our results suggest accounting standardization addresses information externalities and affects the optimal boundaries of the firm.