The Economic Consequences of Expanding Accounting Recognition

35 Pages Posted: 19 Sep 2011 Last revised: 28 Sep 2017

See all articles by Wei Li

Wei Li

University of Washington-Bothell; University of Illinois at Urbana-Champaign - Department of Accountancy

Pierre Jinghong Liang

Tepper School of Business, Carnegie Mellon University

Xiaoyan Wen

Texas Christian University

Date Written: February 8, 2017

Abstract

This paper investigates the economic consequences of including more hard-to-measure future activities in a firm's accounting measurements. Using a simple model of endogenous investment in which payoffs are measured by either a restrictive or expanded recognition rule, we show that, in the process of expanding accounting recognition, firms' internal investment efficiency and external share-price risk premium may not necessarily be a trade-off. In particular, we show that the consequences of an accounting scope expansion depend on the investment environment (e.g., growth prospects) and the inherent measurement characteristics (e.g., measurement noise). For example, even with a higher measurement noise, an expanded accounting recognition may generate a lower risk premium in the share price. More surprisingly, it may lead to a higher investment efficiency and a lower risk premium at the same time. The underlying driving force is that different accounting regimes can affect the risk premium indirectly through their impacts on the investment level, beyond directly through the different measurement noise levels they bring.

Keywords: accounting measurement regimes; measurement scope; measurement noise; risk premium

JEL Classification: G12, G38, M41

Suggested Citation

Li, Wei and Liang, Pierre Jinghong and Wen, Xiaoyan, The Economic Consequences of Expanding Accounting Recognition (February 8, 2017). Available at SSRN: https://ssrn.com/abstract=1929057 or http://dx.doi.org/10.2139/ssrn.1929057

Wei Li

University of Washington-Bothell ( email )

18115 Campus Way NE
Bothell, WA 98011
United States

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

4009 BIF
515 E Gregory Drive
Champaign, IL 61820
United States
217-265-0293 (Phone)

Pierre Jinghong Liang

Tepper School of Business, Carnegie Mellon University ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-3315 (Phone)
412-268-6837 (Fax)

HOME PAGE: http://www2.tepper.cmu.edu/andrew/liangj

Xiaoyan Wen (Contact Author)

Texas Christian University ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States

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