The Information Content of Earnings: The Effects of a Change in Accounting Approach

Abstract

This study leverages the adoption of ASC 606, “Revenue from Contracts with Customers,” to examine the effects of transitioning from a rules‐based to a principles‐based approach on the information content of earnings along with two of its most important attributes: predictive value and asymmetry. By introducing a common principles‐based framework, ASC 606 resolves inconsistencies found in earlier rules‐based standards and fosters uniformity in financial reporting. However, this change might also diminish the uniqueness of financial information, a critical factor in the decision‐making process. The findings reveal a significant increase in the overall market's information content of earnings post‐ASC 606 implementation. Industries with complex revenue recognition processes and long‐term contracts, such as information technology, real estate, and communications, experienced the most significant improvements. These industries benefited from the increased flexibility and professional judgment allowed under ASC 606, resulting in more accurate future earnings forecasts. However, the study also finds that ASC 606 has increased information asymmetry, particularly in industries with complex transactions. This suggests that while the principles‐based approach enhances the informativeness and predictive value of earnings, it also introduces challenges in interpreting and applying the new standards, leading to increased information asymmetry. These findings have important implications for standard setters, regulators, and practitioners in financial reporting.