The Effect of Discretion in Accounting Standards on Financial Reporting Comparability

Adam John Bordeman, University of Colorado Boulder


One objective of financial reporting regulation is to encourage the production of decision-useful information. This paper examines the association between the level of discretion allowed in financial reporting standards and financial reporting comparability, a key characteristic of decision-useful reporting. To study the link between discretion and comparability, I investigate changes in comparability around two regulations, SOP 97-2 and EITF 09-3, which decreased and increased discretion in recognizing revenue on software related transactions, respectively. Using a difference-in-differences research design, I find evidence consistent with greater comparability for affected firms in periods of more discretion, relative to a control sample. This positive association between discretion and comparability is stronger in industries where firms have more similar reporting incentives. This finding supports the idea that reporting incentives moderate the effect of discretion on comparability. Next, I examine if the decision-usefulness of comparability changes after each regulation. My tests of stock market reactions for treatment and control firms around peer earnings announcements provide evidence that information transfers are greater between comparable peers in periods of more discretion. However, I do not find evidence that these changes in discretion impact how analysts process information from comparable peers.