Financial Reporting Discretion and Corporate Voluntary Disclosure: Evidence from the Software Industry

Abstract

This paper studies the effects of new accounting standards that limit the amount of financial reporting discretion on corporate voluntary disclosure policies. Specifically, it tests the prediction that the decrease in management's discretion with respect to revenue recognition, following the issuance of Statement of Position (SOP) 91-1 in 1992, affected the extent to which managers of software companies voluntarily disclose information outside the financial statements. Consistent with the predictions, the empirical evidence indicates that, relative to a matched control group of non-aggressive reporting firms, managers of aggressive reporting firms reduced the extent to which they issue earnings forecasts, and increased the frequency in which they modify their cash payout policy and disclose non- financial information. Further analysis reveals that earnings management incentives, similar to the ones suggested in the extant accounting literature, do not seem to explain the aggressive revenue recognition practices during pre SOP 91-1 period, and suggests that managers of software companies were using their accounting discretion in an attempt to convey information to investors. Overall, I interpret the empirical findings as evidence of the potential costs associated with new accounting standards that decrease the amount of financial reporting discretion.