Accrual Accounting and Resource Allocation: A General Equilibrium Analysis

I evaluate the role of accrual accounting in improving firms’ production decisions and resource allocation across firms. I introduce both cash flow and accounting earnings as imperfect measures of performance into a general equilibrium model with heterogeneous firms under imperfect information. The model demonstrates firms’ more informed decisions with an improved measure of performance lead to more resources being allocated to potentially high-productivity firms through the product and input markets. The estimated parameter values are consistent with accrual accounting improving managers’ information about future productivity by providing a better measure of performance. The quantitative analysis suggests having accrual accounting information in addition to cash accounting information leads to a 0.7% increase in aggregate productivity and a 1.0% increase in aggregate output through resource allocation in the United States. The estimates are larger in China and India as benchmarks for developing countries: a 1.2%-2.5% increase in aggregate productivity and a 1.7%-3.8% increase in aggregate output. Overall, I demonstrate accrual accounting plays an important role in determining aggregate productivity through resource allocation.