Are Financial Statements More Comparable When GAAP Restricts Managers’ Discretion?

Abstract

This study examines whether financial statements are more comparable when accounting standards restrict managers’ discretion. I measure the extent to which GAAP restricts managers’ discretion by counting the number of times obligatory language is used in each standard. My primary findings suggest financial statements are less comparable when GAAP restricts managers’ discretion and that this effect is driven by dissimilar transactions appearing similar. Further, using SFAS 141 and SFAS 86 as salient examples, I provide evidence that accounting for similar transactions using similar accounting treatments, as required by SFAS 141, is associated with more comparable financial statements, yet accounting for dissimilar transactions using similar accounting treatments, as required by SFAS 86, is associated with less comparable financial statements. I also find that the impact of restricting managers’ discretion on comparability is attenuated when managers have incentives to manipulate earnings but only when managers are prevented from manipulating successfully. Last, I find that the decline in comparability associated with restricting managers’ discretion drives an increase in the cost of equity.