Imperfect Accounting and Reporting Bias

Vivian W. Fang, Allen H. Huang, Wenyu Wang

Research output: Contribution to journalArticle

7 Scopus citations

Abstract

Errors and bias are both inherent features of accounting. In theory, while errors discourage bias by lowering the value relevance of accounting, they can also facilitate bias by providing camouflage. Consistent with theory, we find a hump-shaped relation between a firm's propensity to engage in intentional misstatement and the prevalence of unintentional misstatements in the firm's industry for the whole economy and a majority of the industries. The result is robust to using firms’ number of items in financial statements and exposure to complex accounting rules as alternative proxies for errors and to using the restatement amount in net income to quantify the magnitude of bias and errors. To directly test for the two effects of errors, we show that when errors are more prevalent, the market reacts less to firms’ earnings surprises and bias is more difficult to detect. Our results highlight the imperfectness of accounting, advance understanding of firms’ reporting incentives, and shed light on accounting standard setting.

Original languageEnglish (US)
Pages (from-to)919-962
Number of pages44
JournalJournal of Accounting Research
Volume55
Issue number4
DOIs
StatePublished - Sep 2017

    Fingerprint

Keywords

  • G32
  • G34
  • G38
  • M40
  • M41
  • M48
  • M53
  • accounting errors
  • accounting regulation
  • earnings response coefficient
  • fraud
  • fraud detection
  • reporting bias
  • textual analysis

Cite this