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On the Relation between Conservatism in Accounting Standards and Incentives for Earnings Management

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  • QI CHEN
  • THOMAS HEMMER
  • YUN ZHANG
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    Abstract

    ABSTRACT This paper studies the role of conservative accounting standards in alleviating rational yet dysfunctional unobservable earnings manipulation. We show that when accounting numbers serve both the valuation role (in which potential investors use accounting reports to assess a firm's expected future payoff) and the stewardship role (in which current shareholders rely on the same reports to monitor their risk-averse manager), current firm owners have incentives to engage in earnings management. Such manipulation reduces accounting numbers' stewardship value and leads to inferior risk sharing. We then show that risk sharing, and hence contract efficiency, can be improved under a conservative accounting standard where, absent earnings management, accounting earnings represent true economic earnings with a downward bias, compared with under an unbiased standard where, absent earnings management, accounting earnings represent true economic earnings without bias. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2007.

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Journal of Accounting Research.

    Volume (Year): 45 (2007)
    Issue (Month): 3 (06)
    Pages: 541-565

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    Handle: RePEc:bla:joares:v:45:y:2007:i:3:p:541-565

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    Cited by:
    1. Alfred Wagenhofer, 2009. "Global accounting standards: reality and ambitions," Accounting Research Journal, Emerald Group Publishing, vol. 22(1), pages .68-80, July.
    2. Göx, Robert F. & Wagenhofer, Alfred, 2009. "Optimal impairment rules," Journal of Accounting and Economics, Elsevier, vol. 48(1), pages 2-16, October.
    3. Gao, Pingyang, 2013. "A measurement approach to conservatism and earnings management," Journal of Accounting and Economics, Elsevier, vol. 55(2), pages 251-268.
    4. Langberg, Nisan & Sivaramakrishnan, K., 2008. "Voluntary disclosures and information production by analysts," Journal of Accounting and Economics, Elsevier, vol. 46(1), pages 78-100, September.
    5. Rahimah Mohamed Yunos Author_Email: rahim221@johor.uitm.edu.my & Malcolm Smith & Zubaidah Ismail & Syahrul Ahmar Ahmad, 2011. "Inside Concentrated Owners, Board Of Directors And Accounting Conservatism," Annual Summit on Business and Entrepreneurial Studies (ASBES 2011) Proceeding 2011-053-178, Conference Master Resources.
    6. Armstrong, Christopher S. & Guay, Wayne R. & Weber, Joseph P., 2010. "The role of information and financial reporting in corporate governance and debt contracting," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 179-234, December.
    7. Budde, Jörg, 2013. "Verifiable and Nonverifiable Information in a Two-Period Agency Problem," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 445, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    8. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    9. Joachim Gassen, 2008. "Are stewardship and valuation usefulness compatible or alternative objectives of financial accounting?," SFB 649 Discussion Papers SFB649DP2008-028, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.

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