The Commitment to Income‐Decreasing Accounting Choices as a Credible Signal to Reducing Information Asymmetry: The Case of Asset Revaluations

• Published in: Contemporary accounting research 2020-12, Vol.37 (4), p.2501-2522
• Main Authors: Costa, Fábio Moraes, Liu, Carol, Rosa, Gina Cavalier, Tiras, Samuel L.
• Format: Article
• Language: English
• Subjects: Accounting; Assets; Asymmetric information; Asymmetry; asymétrie de l'information; Capital; choix comptable axé sur une diminution des gains; Companies; Earnings; engagement préalable; Exploitation; Financial reporting; income‐decreasing accounting choice; information asymmetry; International Financial Reporting Standards; precommitment; Prospects; réévaluations d'actifs à la hausse; Sacrifices; upward asset revaluations; Volatility
• ISSN: 0823-9150; 1911-3846
• DOI: 10.1111/1911-3846.12606

ABSTRACT Bagnoli and Watts (2005) proposed that a manager could reduce information asymmetry by choosing an income‐decreasing accounting choice that signals the firm's relatively good future prospects. A limitation in testing this theory is that most income‐decreasing accounting choices over time reverse such that aggregated earnings would be the same, regardless of the choice. One income‐decreasing accounting choice that never reverses is the choice of upward asset revaluation, where the resulting gains are recognized through other comprehensive income and reduce future earnings by increasing future depreciation expense. In the United Kingdom, prior to FRS15, firms had the option to upwardly revalue on a one‐time basis. FRS15, and subsequently International Financial Reporting Standards, however, require those firms that upwardly revalue precommit to revalue on a consistent basis. This precommitment sacrifices future reporting discretion, which, according to the aforementioned study, serves as a costly signal of a firm's relatively good future prospects that reduces information asymmetry. The choice not to upwardly revalue, therefore, serves as a signal of a firm's relatively poor future prospects and also reduces information asymmetry, but this choice does not require precommitment such that the reduction in information asymmetry would be less than the choice to precommit to upward revaluations. Using a propensity‐score matched‐pair design on a sample of United Kingdom firms to test our predictions during the period requiring precommitment, we find lower forecast dispersion, lower return volatility, and a lower cost of capital for firms that precommit to upward asset revaluations, relative to those firms that choose not to upwardly revalue their operating assets. Keywords: upward asset revaluations, income‐decreasing accounting choice, information asymmetry, precommitment RÉSUMÉ Engagement à faire des choix comptables axés sur une diminution des gains en tant que signal crédible pour réduire l'asymétrie de l'information : le cas des réévaluations d'actifs Bagnoli et Watts (2005) proposent qu'un gestionnaire pourrait réduire l'asymétrie de l'information en optant pour un type de comptabilité axé sur une diminution des gains qui signale que les perspectives de la société sont relativement bonnes. Une des limites de la mise à l'essai de cette théorie est que la plupart des choix comptables axés sur une diminution des gains s'inversent au fil du temps de tel