Properties of Optimal Accounting Rules in a Signaling Game

• In Event: Financial Accounting Theory

Abstract

We characterize the properties of optimal accounting rules in a signaling game where an impatient entrepreneur sells shares to competitive investors. The entrepreneur can signal her private information about the fundamental of the firm by retaining a fraction of the shares. In addition, she can commit to disclosing information according to a set of accounting rules chosen ex ante. Information disclosure reduces signaling cost so that perfect diclosure is optimal. However, perfect disclosure requires disclosing infinite amount of information (measured by reduction of Shannon's entropy), which is usually unrealistic. When disclosure can only reveal finite amount of information, the optimal accounting rule features an infimum and a summary statistic of the fundamental. The infimum corresponds to accounting conservatism while the statistic summarizes the most relevant information determined by the signalling game.

Authors

• Xu Jiang, Duke University

• Ming Yang, Duke University