Segment Disclosure Under the Management Approach : The Impact of Proprietary Costs on Internal Reporting Decisions

Accounting standards for external segment reporting purposes stipulate aggregation of information in line with the internal structure of the firm. This method of segment reporting is referred to as the "management approach." In this paper, we analyze the optimal disclosure of proprietary information when firms face a competitive threat from potential entrants into an industry. If external segment disclosure has to be aligned with internal segment reports, then disaggregated information allows for an efficient allocation of resources but eventually attracts competition by revealing proprietary information to potential entrants. In contrast, aggregated information implies inefficient decisions but eventually prevents competitors from entering the market. Our results show that aggregation arises for two reasons: It can be an instrument to prevent a competitor from entering the market or aggregated information can even be optimal if the competitor's market entry cannot be avoided or even more surprisingly if aggregated information attracts competition. In this case, aggregated information serves as a commitment device to reduce the intensity of competition