On the Social Value of Accounting Objectivity in Financial Stability

In this paper, we analyze the social value of accounting objectivity in maintaining …nancial stability. Building on an early, in‡uential accounting study by Ijiri and Jaedicke (1966), we operationalize two informational properties, accuracy (free of collective bias) and objectivity (degree of consensus), in a correlated information structure and embed them into a model of runs on …nancial institutions. We show that, when compared with the accuracy property, the objectivity property exhibits an advantage in mitigating ine¢ cient, panic-based runs. In fact, it is possible that improving objectivity discourages such runs whereas improving accuracy encourages them. Our model also sheds light on the design of optimal accounting systems to enhance objectivity. We …nd that, to generate a more objective accounting report, accounting systems should be designed to be less subject to intentional managerial intervention. Keywords: …nancial stability, accounting objectivity, higher-order beliefs, di¤erential interpretation, correlated signals Pierre Jinghong Liang ([email protected]) is from the Tepper School of Business at the Carnegie Mellon University and also has research a¢ liations with Shanghai Advanced Institute of Finance and China Academy of Financial Research at Shanghai Jiaotong University. Gaoqing Zhang ([email protected]) is from the Carlson School of Management at the University of Minnesota. A preliminary version of this paper, titled “Information Objectivity and Accuracy in a Bank Run Model,”was prepared for workshop presentations at the American Accounting Association Annual Meeting, the Accounting Research Workshop in Zurich (Switzerland), Carnegie Mellon University, the Federal Reserve Bank of Richmond, the Institute of Financial Studies at SWUFE (China), Texas A&M University, and the University of Minnesota. We are grateful for the comments received there, especially from Sabine Bockem, Phil Dybvig, Huberto Ennis, Pingyang Gao, Borys Grochulski, Xu Jiang, Chandra Kanodia, Michael Kirschenheiter, Mark Loewenstein, Brian Mittendorf, Ned Prescott, Korok Ray, and Ulf Schiller. Pierre Liang gratefully acknowledges the Dean’s Summer Research funding of the Tepper School.