How Much Does Imprecision in Accounting Measurement Enhance Value?

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2022
Authors
Liang, Ying
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Theory on real effects suggests that more precise accounting does not necessarily improve investment efficiency. However, with investment efficiency mostly unobservable, empirical assessment of the theory is rare. This paper develops an empirical framework based on Kanodia, Singh, and Spero (2005) to structurally estimate the effect of imprecision in accounting measurement on investment efficiency. My estimates suggest that imprecision in accounting measurement has mitigated over-investment in capital expenditures and R&D by 28.6% and 4.9%, respectively. On average, firms still over-invest relative to the first-best full-information benchmark. In counterfactual analyses, my estimates suggest that the optimal investment efficiency could be achieved by reducing the current accounting precision by four percentage points (19.5 percentage points) in capital expenditures (R&D), which would increase investor welfare by 4.2% (22%). My study is among the first to provide a quantitative assessment of real effects and presents early evidence of excessive precision in accounting measurement.
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accounting measurement, investment, real effects
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