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Market Transparency and the Accounting Regime

Market Transparency and the Accounting Regime ABSTRACT We model the interaction of financial market transparency and different accounting regimes. This paper provides a theoretical rationale for the recently proposed shift in accounting standards from historic cost accounting to marking to market. The paper shows that marking to market can provide investors with an early warning mechanism while historical cost gives management a “veil” under which they can potentially mask a firm's true economic performance. The model provides new explanations for several empirical findings and has some novel implications. We show that greater opacity in financial markets leads to more frequent and more severe crashes in asset prices (under a historic‐cost‐accounting regime). Moreover, our model indicates that historic cost accounting can make the financial market more rather than less volatile, which runs counter to conventional wisdom. The mechanism shown in the model also sheds light on the cause of many financial scandals in recent years. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Accounting Research Wiley

Market Transparency and the Accounting Regime

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References (25)

Publisher
Wiley
Copyright
Copyright © 2007 Wiley Subscription Services, Inc., A Wiley Company
ISSN
0021-8456
eISSN
1475-679X
DOI
10.1111/j.1475-679X.2007.00231.x
Publisher site
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Abstract

ABSTRACT We model the interaction of financial market transparency and different accounting regimes. This paper provides a theoretical rationale for the recently proposed shift in accounting standards from historic cost accounting to marking to market. The paper shows that marking to market can provide investors with an early warning mechanism while historical cost gives management a “veil” under which they can potentially mask a firm's true economic performance. The model provides new explanations for several empirical findings and has some novel implications. We show that greater opacity in financial markets leads to more frequent and more severe crashes in asset prices (under a historic‐cost‐accounting regime). Moreover, our model indicates that historic cost accounting can make the financial market more rather than less volatile, which runs counter to conventional wisdom. The mechanism shown in the model also sheds light on the cause of many financial scandals in recent years.

Journal

Journal of Accounting Research – Wiley

Published: May 1, 2007

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