Value Irrelevance of the Reported Earnings Numbers and Informativeness of the Asset Price under the Conservative Accounting: Implications on Mark to Market Accounting

Abstract

This paper presents an one-period model of an one-asset market allowing for the strategic interaction among rational traders and earnings fixated traders. Earnings fixated traders are functionally fixated on the reported earnings numbers in formulating their trading strategies without paying attention to the accounting procedures used to generate those numbers. This paper shows analytically that under the conservative accounting, the reported accounting earnings numbers are value-irrelevant and the informativeness of the asset price improves as the volatility of the reported earnings increases towards the volatility of the economic earnings of the asset. These results support the alternative accounting of mark to market.