Judgment-based Accounting Standards and Stock Price Information

Abstract

This paper examines whether judgment-based accounting standards, defined as standards that require greater managerial judgments and estimates, result in more firm-specific information in stock prices. Using thirteen judgment-related standards and leveraging the latest Large Language Model (LLM) techniques to read and interpret firm disclosures to identify the firm-specific impact of standards, I employ a cohort-based difference-in-differences regression model to compare firm-specific information in prices between firms affected by the standards and those unaffected around the adoption of these standards. I find that, upon the adoption of these standards, affected firms requiring more judgment, on average, experience an increase in firm-specific information about firm fundamentals in prices, relative to unaffected firms. Exploring the mechanism, I find that this increase in information is attributable to more informative financial reports and more private information production by traders. Exploring the consequence, I document that liquidity improves for affected firms. These findings add to the understanding of required judgment in standard-setting and offer new perspectives on the role of standards in facilitating efficient capital allocation.