Accounting Standard Setting in the Presence of Uninformed Investors

Abstract

This paper constructs a model of a standard setting game among informed and uninformed investors, an auditor and standard setters to examine how accounting standard setting interacts with informed and uninformed investors' investment decisions. It proves that the levels of investments of informed and uninformed investors increase with the increase in the accounting standards in the case of bad report (about the project's ability of generating cash flow) being issued by an auditor; however, in the case of good report (about the project's ability of generating cash flow) being issued by the auditor, the levels of investments of informed and uninformed investors can move in the opposite directions as the accounting standard increases. In addition, this paper shows that regardless of investors being informed or not about the project's ability of generating cash flow, the Stackelberg equilibrium accounting standard can lead to a positive expected value of the project.