The Effect of Uncertainty about Future Accounting Standards on Financial Reporting Quality

Abstract

Financial statement preparers often make accounting judgments with considerable uncertainty about what future accounting standards will require. We conduct a study in the experimental economics tradition to investigate how such uncertainty affects preparers’ current period accounting estimates. Compared to preparers who know with certainty that future standards will allow them to benefit from reporting a biased accounting estimate in the present, we find that preparers who face uncertainty about future standards arrive at less biased estimates. We further find that this reduction in bias reflects a behavioral response from preparers that is in conflict with their wealth-maximizing financial incentives. Moreover, we find evidence that uncertainty about future standards causes preparers to rely more on their unbiased private information about estimate value, and focus less on the potential benefits of biased reporting. Although uncertainty associated with standard setting is often criticized, our theory and results suggest that increased financial reporting quality is an unanticipated benefit of the uncertainty that naturally arises from a deliberative and inclusive standard setting process.