The Power of Accounting Recognition beyond Disclosure: an Incomplete Contracts Approach∗

I use the incomplete contracts approach to distinguish accounting recognition from disclosure. Accounting recognition settles contracts while disclosure facilitates armslength transactions. The endogenous power of recognition in settling contracts unilaterally makes it vulnerable to influence activities more than disclosure. In particular, recognition is susceptible to transparent influence activities from which disclosure is immune. The extra vulnerability of recognition to influence activities calls for special safeguards that are otherwise viewed as excessive from the disclosure perspectives. Examples of such safeguards include the restriction of the use of expectations (transaction-based recognition) and the asymmetric use of expectations (conservatism). ∗I thank many of my colleagues at Chicago Booth for inspiring discussions on this topic. I also thank Ulf Bruggemann for able research assistance.