Strategic consequences of historical cost and fair value measurements

This paper examines the measurement of nonfinancial assets in imperfectly competitive markets and considers the effect of alternative measurements on firms' investing and operating activities. We analyze a duopoly where each firm manufactures, reports, and thereafter sells its inventory. We initially characterize the informativeness of a firm's accounting report when it is prepared using historical cost and find that a firm's report does not always reveal its level of inventory. We then characterize the informativeness of a report when it is prepared using fair value and find that it completely reveals a firm's inventory holding. We highlight the difficulty of implementing fair value measurements that arise because fair value is an endogenous consequence of the strategic interaction between firms.