Strategic Withholding and Imprecision in Asset Measurement

• Published date: 01 December 2021
• Author: JEREMY BERTOMEU,EDWIGE CHEYNEL,DAVIDE CIANCIARUSO
• Date: 01 December 2021
• DOI: http://doi.org/10.1111/1475-679X.12390

DOI: 10.1111/1475-679X.12390

Journal of Accounting Research

Vol. 59 No. 5 December 2021

Printed in U.S.A.

Strategic Withholding and

Imprecision in Asset Measurement

JEREMY BERTOMEU,∗EDWIGE CHEYNEL,∗

AND DAVIDE CIANCIARUSO†

Received 19 November 2019; accepted 28 March 2021

ABSTRACT

Does managing the production of information add value in economic envi-

ronments where a manager may claim to be uninformed and withhold un-

favorable news? We examine this question by nesting an optimal persuasion

mechanism, controlling how evidence is organized, within a voluntary disclo-

sure framework. Information has productive consequences because the firm

uses it to make a continuous operating decision. The optimal reporting strat-

egy features coarse information at the most unfavorable reported event if

and only if the firm bears penalties for nondisclosure or positive disclosure

costs. The model demonstrates the optimality of imprecise information over

bad news in a voluntary disclosure environment, and that such imprecision

∗John M. Olin School of Business at Washington University in St. Louis, 1 Snow Way Drive,

St. Louis, MO, 63130, USA; †HEC Paris, 1 Rue de la Libération, Jouy-en-Josas, 78350, France

Accepted by Phil Berger. We thank brown bag and workshop participants at the 11th

ARW in Zurich, the 2nd Accounting Theory Conference at HKU, the HARC 2020, Ari-

zona State, Baruch College, HEC Paris, HSE Moscow, Urbana Champaign, UCSD, and Uni-

versity of Zurich. We are also grateful to Snehal Banerjee, Bruno Biais, Matt Bloomfield

(discussant), Bradyn Breon-Drish, Sofya Budanova, Levent Celik, Gilles Chemla, Hui Chen,

Ron Dye, Henry Friedman, Pingyang Gao, Robert Göx, Denis Gromb, Xu Jiang, Iván Mari-

novic, Phil Stocken (discussant), Ross Valkanov, Igor Vaysman, and Hao Xue for suggestions

on earlier versions of the paper. An online appendix to this paper can be downloaded at

http://research.chicagobooth.edu/arc/journal-of-accounting-research/online-supplements.

Email: bjeremy@wustl.edu

1523

© 2021 The Authors. Journal of Accounting Research published by Wiley Periodicals LLC on behalf of The

Chookaszian Accounting Research Center at the University of Chicago Booth School of Business

This is an open access article under the terms of the CreativeCommonsAttribution-NonCommercial

License, which permits use, distribution and reproduction in any medium, provided the original work is

properly cited and is not used for commercial purposes.

1524 j. bertomeu, e. cheynel, and d. cianciaruso

increases the quality of public signals after considering strategic disclosure ef-

fects.

JEL codes: C72, D21, D53, D82, M41

Keywords: production,imprecision,voluntary disclosure,accounting stan-

dards

1. Introduction

Suppose a firm needs to measure an economic asset that may have gained

or lost value. The firm’s accounting policies specify which measurements

are conducted during the operating cycle. If the measurements always yield

verifiable information, investors may feasibly elicit the manager to publicly

report all information (Milgrom [1981], Grossman [1981]). On occasion,

however, the firm may not obtain verifiable evidence about the economics

of the asset: Uncertainty about whether the measurement has produced

information to be reported in the financial statements creates strategic in-

centives to withhold information (Dye [1985], Jung and Kwon [1988]). In

particular, at the end of the accounting cycle, management receives what

information has been gathered, if any. Even if a loss should be accrued,

management may exert discretion not to make evidence public.

Whatever information the measurement produces affects withholding in-

centives. Understanding this interaction is the objective of this study. Nat-

urally, our model applies to a variety of empirical settings with (1) control

over what information is collected, (2) uncertainty about whether an event

has occurred or there exists hard information to be collected, and (3) the

use of discretion to increase market perceptions. For example, a pharma-

ceutical company may conduct tests to uncover possible side effects that

may affect future sales; a lawyer may collect information prior to a trial; or

a prospective job candidate may obtain recommendations or provide addi-

tional evidence of skills. All of these examples are such that there is control

over the information that is received (the nature and collection of the evi-

dence) and about its disclosure.

We briefly discuss a few illustrations below.Although our model is not in-

tended as descriptive of the institutional details of each of these examples,

the settings are meant to offer applications in which the tradeoffs discussed

here would apply.

First, a firm may implement a finer accounting system that produces

information about the occurrence of past misstatements (Dechow et al.

[2011]): For example, this may be achieved in the form of internal controls

(Marinovic [2013]), including recurrent reviews and checks on past trans-

actions, hiring more effective auditors, or increasing oversight by boards

(Laux [2010]). The market does not know whether such evidence has been

received, and the manager may decide to conduct a restatement based

on the potential impact on earnings or any further reputational conse-

quence. Or, the firm may stealthily conduct a restatement, within venues

strategic withholding and imprecision1525

that make it less forthcoming to market participants. Management must

make a choice whether to report information about a misstatement to an

outside party, but has no simple means to report the absence of the event.

Second, the economic tradeoffs may be considered in the context of dis-

closure of material events, which are required in the United States, for

example, filing of a form 8-K. In principle, any significant material event

should be reported; however, in practice, many events may or may not

be objectively considered material, and firms can be strategic as to which

events to file or when to file (Li [2013]). The reporting policy of the firm

will be a function of how much operational information is collected and

transmitted into the financial reporting system. In addition, many mate-

rial events that could be reported in these filings contain proprietary in-

formation that firms can choose to redact (Verrecchia and Weber [2006],

Heinle, Samuels and Taylor [2020]). More broadly, mandatory accounting

rules allow some level of managerial discretion and judgement (FASC et al.

[2010]).1

Finally, the design of the measurement system may interact with the

accounting measurement but need not concern only accounting-related

events. The Foreign Corrupt Practices Act (FCPA) forbids U.S. companies

to engage in the bribery of foreign officials. Monetary transfers in the pro-

cess of bribing can be uncovered by accounting internal controls; there-

fore, the quality of the accounting system will determine a firm’s ability to

detect whether its employees violate the provisions of the FCPA (Cooper

et al. [1985]). More generally, the quality of the measurement system cho-

sen by the firm will allow it to know whether an illegal act has been com-

mitted by an employee. Rogue trading events (Barings, Société Générale),

failures to report an environmental violation (Volkswagen), or alleged ig-

norance of frauds by management (Enron) are among many examples

in which management may have received coarse information from inter-

nal measurements.

Within this context, we ask two questions. How do we design measure-

ments in the presence of strategic withholding incentives? According to un-

raveling theorems (Milgrom [1981], Grossman [1981]), we may not need

to incorporate strategic considerations into the measurement process if we

can rely on voluntary channels to efficiently supply all information to the

market. But how do measurements affect the voluntary disclosure strategy

when there are frictions that prevent unraveling? We expect very different

disclosure behaviors if measurements are precise than if they are imprecise

with limited verifiable information. Our purpose is thus to merge the two

streams of literature into a theory that speaks about financial reports as a

choice of reporting mechanisms constrained by strategic reporting choices.

1Within the convergence of international rules and U.S. General Accepted Accounting

Principles, standards are becoming more principle based and require some level of managerial

judgement. For example, the recent revenue recognition rules provide managerial discretion

in identifying contracts, as well as the nature and completion of performance obligations.