Accounting Harmonization and Investment Beauty Contests

Abstract

We study the optimal degree of harmonization of accounting standards when firms' investments exhibit "beauty-contest" features as in, e.g., Arya and Mittendorf (2016). We model more harmonization of accounting standards as the noises in firms' reports being more correlated, consistent with Barth et al. (1999). We show that while more harmonized accounting standards have ambiguous effects on the reports' informativeness in representing firms' underlying fundamentals, they always reduce the reports' precision in forecasting firms' aggregate investment. The stronger the "beauty-contest" features, the more important the forecasts about the aggregate investment, and thus the less harmonized the standards should be. We also find that, while absent beauty-contest features, mandatory adoption of more harmonized accounting standards can be unnecessary, such mandate is warranted when beauty-contest features are strong. Taken together, our results both provide a justification for and identify an unintended consequence of the recent mandates towards more harmonized accounting standards.