The Economic Consequences of Expanding Accounting Recognition

This article 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 throug...