The Limitations of Signalling by the Choice of Accounting Methods

✍ Scribed by Ann Gaeremynck

• Book ID: 101287128
• Publisher: John Wiley and Sons
• Year: 1997
• Tongue: English
• Weight: 145 KB
• Volume: 18
• Category: Article
• ISSN: 0143-6570
• DOI: 10.1002/(sici)1099-1468(199702)18:1<33::aid-mde802>3.0.co;2-n

✦ Synopsis

This paper attempts to find an explanation of why empirical evidence does not confirm the signalling hypothesis that income-increasing accounting methods, such as linear depreciation, are typically chosen by firms with positive inside information. First, specific characteristics of the legal environment are required, as signalling by an incomeincreasing accounting method is only possible when the increase in the tax rate and the taxes paid is larger for the unsuccessful firm. Moreover, fiscal law may only offer the discrete choice between linear and accelerated depreciation and a certain method is only allowed for tax purposes when it is also recorded in the financial statements. Because the number of signalling levels offered by the law is limited, signalling by the choice of an income-increasing accounting method can only occur in industries where accelerated depreciation is the value-maximizing choice for all types. Finally, not all firms can reveal positive inside information because contracting structures differ between firms.