Economic consequences of alternative adoption rules for new accounting standards

We develop a theoretical framework that explains firms' reactions to new accounting standards, especially, those released by the FASB under its extended adoption policy. Our theory highlights the differences between recognized and disclosed accounting information, and provides a link between firms' adoption strategy and stock price behavior around the adoption announcemnt. We also consider the relation between delaying information release and renegotiating related contracts. Finally, we analyze the impact of alternative adoption policies allowed by a regulator. We argue that managers utilize the extended adoption period and strategically choose adoption timing and reporting method to convey to the market their private information about the new standard's financial impact. Our model predicts that firms with "favorable" information recognize the impact of the new standard earlier than the mandatory adoption date, firms with "neutral" information disclose the impact in the footnotes to the financial statements, and firms with "unfavorable" information delay reporting until the mandatory adoption date and renegotiate the underlying contract. As a result, a positive market reaction to an early-adoption (recognition) decision is anticipated. In our companion study, Amir and Ziv (1997), we obtain results that are consistent with these predictions, using data on SFAS 106 adoption.