A Theory of the Accounting Accelerator

Abstract

This paper examines the aggregate consequences of accounting standard-setting in economies with financing frictions. We extend the framework of Bernanke and Gertler (1989) and Holmstrom and Tirole (1997) to optimal reporting of productive assets. Our main result is that the accounting process will offset acceleration for small or moderate financial frictions; in fact, the accounting process may make aggregate investment more rigid to decreases in fundamentals. However, for large enough financing frictions, the accounting process contributes to acceleration. The model explains when, given a small decline in fundamentals, the economy may respond with a discontinuous readjustment in accounting standards, prices and investment. The theory offers new hypotheses about the consequences of accounting choice in the aggregate.