2.2: Trade-Offs

As suggested in the previous section, accounting can play a role in reducing both adverse selection and moral hazard. However, because these two problems relate to two different user needs (i.e., the need to predict future investment performance and the need to evaluate management stewardship), it is unlikely that accounting information will always be perfectly and simultaneously useful in alleviating these problems. For example, information about the current values of assets may help an investor better predict the future economic prospects of the company, particularly in the short term. However, current values may not reveal much about management stewardship, as managers have very little control over market conditions. Similarly, the depreciated historical cost of property, plant, and equipment assets can reveal something about management's decision-making processes regarding the purchase and use of these assets, but historical costs provide very little value in estimating future returns. Accounting standard setters recognize that any specific disclosure may not meet all users' needs, and as such, trade-offs are necessary in setting standards. Sometimes trade-offs between different user purposes are required, and sometimes the trade-off is simply a matter of evaluating the cost of producing the information compared with the benefit received. Because of these trade-offs, accounting information must be viewed as an imperfect solution to the problem of information asymmetry. Still, those who set accounting standards attempt to create the framework for the production of information that will be useful to all readers, in particular to the primary user groups of investors, lenders, and creditors.