The Disciplining Role of Accounting
in the Long-Run
ANIL ARYA* firstname.lastname@example.org
Fisher College of Business, The Ohio State University, 2100 Neil Avenue, Columbus, OH 43210-1144
Graduate School of Industrial Administration, Carnegie Mellon University, Tech and Frew Streets,
Pittsburgh, PA 15213-3890
Yale School of Management, 135 Prospect Street, New Haven, CT 06520-8200
The Anderson School at UCLA, 110 Westwood Plaza, Los Angeles, CA 90095-1481
Abstract. One role of accounting is to discipline softer (more manipulable) sources of information. We use
a principal-agent model of hidden actions and hidden information to study this role. In our model, there is
both a veriﬁable signal (a publicly observed output) and an unveriﬁable signal (a productivity parameter
privately observed by the agent). In a one-period setting, the optimal contract does not make use of the
agent’s report on the private signal. However, when the output is tracked over two periods, the agent’s
communication can be valuable. This reversal of results suggests uncovering the disciplining role of
accounting may require a long-term perspective.
Keywords: long-term contracts, communication, accounting information
JEL Classiﬁcation: D82, M41
Accounting reports serve to introduce new information as well as conﬁrm existing
information. Empirical work is often geared towards the informing role, measuring
incremental information provided by a ﬁrm’s earnings release, for example. Several
studies have documented a relatively weak association between earnings and stock
returns, creating a concern that accounting matters little (Lev, 1989). A related
concern is the timeliness of accounting. For example, Ball and Brown (1968) doc-
ument that about 85–90% of the information contained in earnings is captured by
more timely sources. These results suggest that the conﬁrmatory (disciplining) role of
accounting may be important.
In this paper, we use a principal-agent model of hidden actions and hidden infor-
mation to study the disciplining role of accounting in improving contracting. The main
point of our analysis is that it is sometimes necessary to take a long-term perspective to
uncover the disciplining role.
The results highlight features of accounting that make it
a valuable disciplining device: it is veriﬁed, delayed, and archived.
Review of Accounting Studies, 9, 399–417, 2004
Ó 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.