Second-Order Uncertainty in Accounting Information and Bilateral Bargaining Costs

Abstract

Bargaining costs have been identified as a key determinant of the organization of economic activity, and accounting information plays a significant role in contracts created through bargaining. Properties of accounting information systems can increase or decrease the uncertainty associated with accounting-based payoffs; we show in a bilateral bargaining setting that increased uncertainty leads to increased delays in reaching agreement and increased premiums for the party bearing the uncertainty. We examine two types of uncertainty: first-order (uncertainty about outcomes) and second-order (uncertainty about the probability distributions of outcomes). At a moderately high level of first-order uncertainty, we find that an accounting information system that lowers second-order uncertainty halves the time bargainers need to reach agreement and decreases the premium paid to the bargainer bearing increased risk by 43 percent. The fact that bargaining efficiency gains can arise from accounting systems that reduce second-order uncertainty can help explain the choices firms make in designing and operating their accounting information systems.