The Economics of Accounting

Oxford University Press, Forthcoming

220 Pages Posted: 6 May 2018 Last revised: 25 Jan 2024

See all articles by Richard M. Frankel

Richard M. Frankel

Washington University in Saint Louis - Olin Business School

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Luo Zuo

National University of Singapore; Cornell University

Date Written: November 14, 2023

Abstract

Our objective is to spell out accounting’s economic roles. Our thesis is that earnings and other accounting outputs help firms function more efficiently. Within the firm, accounting information makes contracts work better and aids managerial decisions in the absence of available prices. In capital market exchanges, accounting information ameliorates information asymmetry, thereby enabling price discovery and reducing trading costs. We argue that accounting information is useful in stewardship and valuation despite its limitations. For pedagogical purposes, we first examine the attributes of accounting earnings as produced and received in the market without delving into how the preparers’ incentives influence the fineness of information produced or its properties. Readers can view this discussion as a reduced-form analysis of accounting earnings and their relation to stock prices. After mapping this landscape, we then present a strategic analysis of accounting earnings. This analysis recognizes that accounting information affects users’ and producers’ decisions, which, combined with self-interested behavior, influences the properties of the accounting information produced and affects how it is used in valuation, contracting, and firms’ investment decisions. Shareholder value is our primary efficiency measure, and we also discuss regulatory, social, and contract efficiency. We note that shareholder value maximization and stakeholder protection are not at odds and that accounting information facilitates firms’ commitment to stakeholder protection, which, in turn, leads to more value creation for shareholders.

“The Economics of Accounting is a refreshing and long overdue analysis of the role of accounting in the economy. The authors step back from the deluge of partial results in the literature – most of which is focused on the capital market – and provide the reader with a fine perspective on why accounting exists, what it affects, and in turn what affects the shape it takes. The book should be required reading for all doctoral students and, I suspect, many of their supervisors.” – Ray Ball, Sidney Davidson Distinguished Service Professor of Accounting, University of Chicago, Booth School of Business

“The Economics of Accounting provides an engaging and accessible analysis of the crucial significance of accounting in today’s financial systems. It explores the integral role of accounting in producing information for firm valuation and managerial decision-making. Moreover, it demonstrates accounting’s essential function in shaping and evaluating the agency relationship among shareholders, managers, and other stakeholders. Overall, this insightful work nicely illustrates the economic role of accounting.” – Antoinette Schoar, Stewart C. Myers-Horn Family Professor of Finance and Entrepreneurship, Massachusetts Institute of Technology, Sloan School of Management

Keywords: Accounting, stewardship, valuation, information asymmetry, earnings, stock price, shareholder value, efficiency, stakeholder.

JEL Classification: D82, D86, G10, G12, G14, G30, K22, L21, M41, M42.

Suggested Citation

Frankel, Richard M. and Kothari, S.P. and Zuo, Luo, The Economics of Accounting (November 14, 2023). Oxford University Press, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3165085 or http://dx.doi.org/10.2139/ssrn.3165085

Richard M. Frankel

Washington University in Saint Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

S.P. Kothari (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States
617-253-0994 (Phone)
617-253-0603 (Fax)

Luo Zuo

National University of Singapore ( email )

Cornell University ( email )

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