Classifications Manipulation and Nash Accounting Standards

This paper studies a model of Classifications Manipulation in which accounting reports consist of one of two binary classifications, preparers of accounting reports prefer one classification over the other, and accounting standards designates the official requirements that have to be met to receive the preferred classification, and preparers may engage in classifications manipulation in order to receive their preferred accounting classification. The possibility of classifications manipulation creates a distinction between the official classification described in the statement of the accounting standard and the de facto classification, determined by the shadow standard actually adopted by preparers. The paper studies the selection and evolution of accounting standards in this context. Among other things, the paper evaluates efficient accounting standards, it determines when there will be standards creep, it introduces and analyses the notion of a Nash accounting standard, and it compares the standard set by sophisticated standard setters to those set with less knowledge of firms financial reporting environments.