The Role of Real Effects in Accounting Standard Setting

Abstract

By shaping firms’ information environments, financial accounting potentially induces real effects outside capital markets, including on firms’ business activities. Based on 25 interviews and over 80 sources of public statements, we document that individual standard setters are generally aware of potential real effects when a project starts. However, whereas some view real effects as irrelevant to their standard-setting decisions, others perceive them as relevant costs or benefits to be considered when debating alternative accounting practices. Using the lens of political economy theories, we find that political ideologies shape these differing views, with those arguing in line with free market advocacy viewing real effects as unrelated to standard setters’ remits. In contrast, active-government reasoning coincides with real effects being viewed as relevant for standard setters. These findings shed light on the ideological underpinnings of accounting standards and have implications for real effects studies.

Keywords: Real effects, standard setting, political economy of accounting, political ideology

JEL Classification: G38, K20, M41, M48