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Accounting Conservatism and Managerial Incentives

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  • Young K. Kwon

    (School of Accountancy, Singapore Management University, Singapore 178900, and University of Illinois at Urbana--Champaign, Urbana--Champaign, Illinois)

Abstract

There are two sources of agency costs under moral hazard: (1) distortions in incentive contracts and (2) implementation of suboptimal decisions. In the accounting literature, the relation between conservative accounting and agency costs of type (1) has received considerable attention (cf. Watts 2002). However, little appears to be known about the effects of accounting conservatism on agency costs of type (2) or trade-offs between agency costs of types (1) and (2). The purpose of this study is to examine this void. In a principal-agent setting in which the principal motivates the agent to expend effort using accounting earnings, this study shows that accounting earnings become more useful for reducing agency costs of type (2) when measured conservatively than when measured aggressively. Combined with the result in Kwon et al. (2001) that agency costs of type (1) decrease with accounting conservatism, this analysis suggests that conservative accounting enhances the incentive value of accounting signals with respect to both types of agency costs.

Suggested Citation

  • Young K. Kwon, 2005. "Accounting Conservatism and Managerial Incentives," Management Science, INFORMS, vol. 51(11), pages 1626-1632, November.
    • Handle: RePEc:inm:ormnsc:v:51:y:2005:i:11:p:1626-1632
    DOI: 10.1287/mnsc.1050.0417
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    References listed on IDEAS

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    Cited by:

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    3. Hui Chen & Bjorn N. Jorgensen, 2018. "Market Exit Through Divestment—The Effect of Accounting Bias on Competition," Management Science, INFORMS, vol. 64(1), pages 164-177, January.
    4. Sebastian Kronenberger & Volker Laux, 2022. "Conservative Accounting, Audit Quality, and Litigation," Management Science, INFORMS, vol. 68(3), pages 2349-2362, March.
    5. Francis, Bill B. & Hasan, Iftekhar & Hovakimian, Gayane & Sharma, Zenu, 2023. "Gender pay gap in American CFOs: Theory and evidence," Journal of Corporate Finance, Elsevier, vol. 80(C).
    6. Araceli Mora & Martin Walker, 2015. "The implications of research on accounting conservatism for accounting standard setting," Accounting and Business Research, Taylor & Francis Journals, vol. 45(5), pages 620-650, August.
    7. FU, Qiang & LI, Ming, 2010. "Policy Making with Reputation Concerns," Cahiers de recherche 09-2010, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    8. Hyoungsik Noh, 2023. "Conservativeness in jury decision-making," Theory and Decision, Springer, vol. 95(1), pages 151-172, July.
    9. Christian Lukas & Jens Robert Schöndube, 2008. "Trust and Adaptive Learning in Implicit Contracts," FEMM Working Papers 08017, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    10. Liu, Sun, 2019. "The impact of ownership structure on conditional and unconditional conservatism in China: Some new evidence," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 34(C), pages 49-68.
    11. Raghavan J. Iyengar & Ernest M. Zampelli, 2010. "Does accounting conservatism pay?," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 50(1), pages 121-142, March.
    12. Laux, Volker & Ray, Korok, 2020. "Effects of accounting conservatism on investment efficiency and innovation," Journal of Accounting and Economics, Elsevier, vol. 70(1).
    13. 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.
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    15. Fabio B. Gaertner & Asad Kausar & Logan B. Steele, 2020. "Negative accounting earnings and gross domestic product," Review of Accounting Studies, Springer, vol. 25(4), pages 1382-1409, December.
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