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Why More Forward-Looking Accounting Standards Can Reduce Financial Reporting Quality

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  • Ralf Ewert
  • Alfred Wagenhofer

Abstract

A premise of standard setters and of much empirical research is that improving the quality of accounting standards and their implementation increases information in capital markets. This paper challenges this premise and shows that there are situations in which ‘better’, that is, more forward-looking, accounting standards reduce the information content of financial reports. The reason is that a forward-looking accounting standard affects the smoothness of reported earnings, which can conflict with the manager's smoothing incentive and her willingness to incorporate private information in the financial report. Although the manager could eliminate the effect by earnings management, it is too costly to do so. As a consequence, the capital market's ability to infer the financial and nonfinancial information in reported earnings declines. This finding should increase the awareness that an ‘improvement’ in accounting standards, without considering incentives and other information residing in firms, can adversely affect the quality of financial reporting.

Suggested Citation

  • Ralf Ewert & Alfred Wagenhofer, 2016. "Why More Forward-Looking Accounting Standards Can Reduce Financial Reporting Quality," European Accounting Review, Taylor & Francis Journals, vol. 25(3), pages 487-513, September.
    • Handle: RePEc:taf:euract:v:25:y:2016:i:3:p:487-513
    DOI: 10.1080/09638180.2015.1043927
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    Cited by:

    1. Nezlobin, Alexander & Sloan, Richard G. & Giedt, Jenny Zha, 2022. "Construct validity in accruals quality research," LSE Research Online Documents on Economics 112165, London School of Economics and Political Science, LSE Library.
    2. Manuela M. Dantas & Kenneth J. Merkley & Felipe B. G. Silva, 2023. "Government Guarantees and Banks' Income Smoothing," Papers 2303.03661, arXiv.org.
    3. Stefania Veltri & Francesco De Luca & Ho‐Tan‐Phat Phan, 2020. "Do investors value companies' mandatory nonfinancial risk disclosure? An empirical analysis of the Italian context after the EU Directive," Business Strategy and the Environment, Wiley Blackwell, vol. 29(6), pages 2226-2237, September.
    4. Lanlan Li & Yanlei Gao & Xiudong Wang, 2023. "Impact of Economic Policy Uncertainty on Agribusiness Technology Innovation: Evidence from 231 Listed Firms in China," Sustainability, MDPI, vol. 15(13), pages 1-29, June.
    5. Manuela M. Dantas & Kenneth J. Merkley & Felipe B. G. Silva, 2023. "Government Guarantees and Banks’ Income Smoothing," Journal of Financial Services Research, Springer;Western Finance Association, vol. 63(2), pages 123-173, April.

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