Accounting Transparency and the Asset Substitution Problem

Katrin Burkhardt · Roland Strausz

42 citations0/0 files storedThe Accounting Review

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Auditing, Earnings Management, Governance Corporate Finance and Governance Accounting Theory and Financial Reporting

Abstract

ABSTRACT: We develop a model to show that transparent accounting can worsen the asset substitution effect of debt. This negative effect can outweigh the usual positive effect of transparency. We demonstrate this point by comparing pure historical cost accounting to the conservatively skewed accounting regime of lower-of-cost-or-market (LCM). In a market with asymmetric information, the two regimes lead to different degrees of transparency. The more transparent LCM regime produces more efficient results for firms with lower debt levels, while the opaque rule of pure historical cost accounting is preferable for higher debt levels. We explore the implications of this result for the firm's optimal capital structure.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1970The Market for "Lemons": Quality Uncertainty and the Market Mechanism 1984Corporate financing and investment decisions when firms have information that investors do not have 1984The Capital Structure Puzzle 1984Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have 1991Disclosure, Liquidity, and the Cost of Capital 1984The Capital Structure Puzzle 2004Information and the Cost of Capital

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