Equilibrium Analysis of Accounting Standards and Enforcement on Economic Growth

Description

In this proposed study, I argue that an important difference between well-developed and less-developed economies is the efficiency of financial reporting standards in conjunction with regulatory enforcement. Financial reporting standards play a critical role in capital allocation across firms in an economy. Over time, an economy accumulates wealth, which can be reallocated to productive activities, thereby promoting economic growth and prosperity. As a result, economic activities affected by financial reporting standards in previous periods have a lingering effect on future periods. To capture this idea, I propose a dynamic general equilibrium model of accounting standards and regulatory enforcement. The presence of financial reporting manipulation interrupts efficient capital allocation across firms, thereby lowering contemporaneous economic activities and aggregate wealth in an economy. I will show that financial reporting manipulation in one period not only lowers the contemporary economic performance but also interferes with the course of the economic growth process from that point forward. The dynamic general equilibrium approach in this proposed study will make it possible to analyze the magnitude of macroeconomic consequences of investment, consumption, and welfare and thus better assess the impact of accounting policies. The main contributions of the proposed study are as follows. First, this study will contribute to the literature on accounting standards and enforcement by analyzing macroeconomic outcomes in a multi-firm setting. For policy-makers, a full assessment of accounting standards requires understanding aggregate outcomes and interactions among different stakeholders in an economy. The general equilibrium approach will allow me to analyze the macroeconomic consequences of accounting standards, thereby enabling the assessment and promotion of desirable accounting policies. Second, this study will also contribute to the earnings management literature by identifying a dynamic linkage between corporate fraud and future economic activities. In this proposed study, manipulated accounting reports bequeath a negative externality to subsequent generations by reducing accumulated wealth in an economy, which can lower economic activities (investment) from the next period onwards. That is, a corrupt economy accumulates less wealth and induces slower growth. Lastly, this proposed study has the potential to contribute to the literature on the role of accounting policies in economic growth. By analyzing the dynamic general equilibrium under different accounting policies, this study will highlight that financial reporting plays a critical role in the course of economic growth through capital allocation and accumulation over time.