ABSTRACT
Corporate managers often express concern about accounting-induced volatility in financial statements. Accounting regulators, however, argue that the volatility in financial statements merely increases transparency by shining a light on risks that are inherent to the firm’s business. We show that in many situations managerial concerns about volatility are justified because the information that is being provided actually magnifies rather than merely reflects the volatility in a firm’s fundamentals. Corporate managers anticipate the magnified volatility and take preemptive actions to decrease the firm’s exposure to the accounting treatment that induces volatility. These actions may not be in the best interests of external stakeholders, making disclosure costly, while at the same time improving the decisions of external stakeholders. We develop and study the resultant tradeoff that accounting regulators should consider in setting accounting standards.
