Nonfinancial Information and Accounting: A Reconsideration of Benefits and Challenges

Abstract

SYNOPSIS: Recent years have seen widespread interest in supplementing or replacing accounting information with nonfinancial information (NFI) in a variety of uses such as incentive compensation, prediction of costs and profits, and firm valuation. The joint use of NFI and accounting has had mixed results, however. Research has documented benefits to such use but has also documented significant challenges. This commentary summarizes research that addresses two particularly important challenges in using combinations of accounting and NFI: measuring nonfinancial performance accurately and weighting measures appropriately when multiple accounting and nonfinancial measures are used together. These challenges are related, in that the nature and magnitude of measurement error helps to determine appropriate weights on multiple measures. Two common themes appear in strategies for dealing successfully with these challenges. The first is that matching information properties to decision types can limit the need for costly or infeasible improvements in measurement. Measurement errors that have significant negative impact on some decisions can be innocuous when the information is used for other decisions. The second theme is a portfolio approach to measurement error: the negative decision effects of error in individual measures can be significantly mitigated by well-chosen combinations of NFI and accounting measures.

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