Accrual Accounting and Resource Allocation: A General Equilibrium Analysis

Abstract

ABSTRACTThis paper evaluates the role of accrual accounting in improving firms' production decisions and resource allocation across firms. I introduce two imperfect firm‐performance measures, cash flows and accounting earnings, into a general equilibrium model with heterogeneous firms under imperfect information. The model demonstrates that improvements in measurement systems lead to more informed decisions on the part of firms and ultimately to allocation of greater resources to high‐productivity firms via the product and input markets. Estimated parameter values are consistent with accrual accounting improving managers' information about current productivity by providing a better measure of historical firm performance. Quantitative analysis suggests that introducing accrual‐accounting information on top of cash‐accounting information leads to a 0.5% increase in aggregate U.S. productivity and a 0.7% increase in aggregate U.S. output via improved resource allocation. The corresponding estimates for China and India, as benchmarks for developing countries, are larger: a 1.5% to 2.3% increase in aggregate productivity and a 2.3% to 3.4% increase in aggregate output. I conclude that accrual accounting plays a significant role in determining aggregate productivity via improved resource allocation.