What should GAAP look like?
) (University of Chicago Booth School of Business) Abstract Based on extant literature, we articulate a positive theory of GAAP under the assumption that the objective is to facilitate the efficient allocation of capital within an economy. The theory predicts that GAAP’s principal focus, as shaped by the demand for and supply of financial information, is on the use of the income statement and balance sheet for performance measurement and control (stewardship). This is consistent with efficient contracting considerations guiding financial reporting. Financial reports produced under this model also generate information useful for equity valuation but this is not the primary objective. Thus, artificially imposing equity valuation as the primary objective of financial reporting standards will result in GAAP rules that are unlikely to serve stakeholders’ needs. The theory allows us to compare and contrast extant GAAP, as observed in a regulated setting, with GAAP that might arise endogenous
