Managers are given reporting discretion for a good reason e.g., Watts and Zimmermann
1986. On one hand, reporting discretion allows managers to use their private information to
produce reports that more accurately reflect firm performance and are more informative to outside
parties. On the other hand, whether managers use their reporting discretion in this way depends on
their reporting incentives. Managers may also have incentives to obfuscate economic performance,
achieve certain earnings targets, avoid covenant violations, underreport liabilities, or smooth
earnings to name just a few. Given managers’ information advantage, even vis-a-vis the auditors
and enforcement agencies, it is difficult to constrain such behavior. But the issue is not just a
matter of proper enforcement of the accounting standards. While strict enforcement limits the
amount of discretion that managers have, it does not eliminate it. Even in a hypothetical world
with perfect enforcement, observed reporting behavior will differ across firms as long as the
accounting standards offer discretion, and there are differences in reporting incentives across firms
Leuz 2006.