Are Financial Statements More Comparable When GAAP Restricts Managers' Discretion?

This article investigates whether financial statement comparability improves when Generally Accepted Accounting Principles (GAAP) restrict managers' discretion in accounting choices. Using a novel measure of GAAP restrictions based on obligatory language ("shall," "should," "must") and a large sample of U.S. firms from 1993 to 2016, the study finds that, on average, restricting managerial discretion is associated with reduced comparability, especially when firms’ transactions are dissimilar. The research develops a theoretical framework distinguishing two types of incomparability—dissimilarity-masking (dissimilar transactions appearing similar) and similarity-masking (similar transactions appearing dissimilar)—and shows that GAAP restrictions increase incomparability due to dissimilar transactions appearing overly similar. However, in specific cases where standards limit managerial manipulation or eliminate inappropriate diverse accounting treatments (e.g., SFAS 141 on business combinations), restrictions enhance comparability. Additionally, the study finds that increased GAAP restrictions correlate with a modestly higher cost of equity, partly mediated by reduced comparability. These findings suggest a nuanced relationship between managerial discretion and comparability, influenced by transaction similarity and managerial incentives, with implications for accounting standard setters evaluating the trade-offs of prescriptive guidance.