Voluntary Disclosure and Earnings Management

Date
2017-08-17
Authors
Xin, Baohua
Jiang, Xu
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Abstract
Discretion pervades the accounting rules. Proponents argue that allowing discretion enables managers to incorporate more information in their disclosures, while opponents believe that managers can abuse discretion and engage in earnings management at the expense of shareholders. We explicitly model accounting discretion and earnings management in a disclosure setting motivated by Shin (1994). We use this setting to study the interaction between management’s voluntary disclosure and the subsequent mandatory disclosure of value-relevant information. We show that, in equilibrium, allowing the manager to have some discretion over the mandatory financial reports may enhance the informativeness of the more-timely voluntary disclosure. However, allowing too much discretion for earnings management may result in less informative voluntary disclosure. Thus there may be a hidden benefit of granting some (but not too much) discretion in firms’ mandatory financial statements.
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Keywords
voluntary disclosure, earnings management, accounting discretion
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