Accounting Standards, Regulatory Enforcement, and Investment Decisions ∗

We examine the influence of accounting standards and regulatory enforcement on reporting quality and investment efficiency. First, we find isolated changes to standards can have unintended consequences on reporting quality if their enforcement remains unchanged. In particular, raising accounting standards without improving enforcement can backfire and reduce reporting quality, which negatively impacts resource allocation decisions. Second, we find an increase in enforcement should be combined either with tougher or weaker standards depending on the structure of the regulatory penalties. Thus, standards and enforcement are either substitutes or complements. In this light, we advocate the careful coordination of standard-setting and regulatory enforcement to enhance investment efficiency.