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The role of accrual accounting in restricting dividends to shareholders

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  • Christian Leuz

Abstract

This paper addresses the question why net earnings and other accrual accounting numbers are frequently used to restrict dividends to shareholders. Even though this role of accrual accounting is widely accepted in the literature, a theory explaining the role of accruals in dividend restrictions is still in its early stages. Building on the principal-agent framework, I argue that basic features of the accrual process can be viewed as arising from the demand for dividend restrictions mitigating debt-related incentive problems. This explanation is consistent with the observation that, historically, debt contracting, dividend restrictions and the development of accrual accounting have been closely related. The basic idea is that the use of transactions and events in the accrual process leads to a contingent specification of the upper bound on dividends in an earnings-based constraint. Transactions and events used in the accrual process can be viewed as imperfect, but verifiable indicators for (unverifiable) determinants of debt-related incentive problems. This general idea is applied to incentive problems that regularly arise in a multi-period context. The paper demonstrates that the accrual process may mitigate distortions in shareholders' investment decisions using provisions and depreciation charges as examples.

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  • Christian Leuz, 1998. "The role of accrual accounting in restricting dividends to shareholders," European Accounting Review, Taylor & Francis Journals, vol. 7(4), pages 579-604.
    • Handle: RePEc:taf:euract:v:7:y:1998:i:4:p:579-604
    DOI: 10.1080/096381898336204
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    1. Igor Goncharov & Sander Triest, 2014. "Unintended Consequences of Changing Accounting Standards: The Case of Fair Value Accounting and Mandatory Dividends," Abacus, Accounting Foundation, University of Sydney, vol. 50(3), pages 341-367, September.
    2. Jung Ho Choi, 2021. "Accrual Accounting and Resource Allocation: A General Equilibrium Analysis," Journal of Accounting Research, Wiley Blackwell, vol. 59(4), pages 1179-1219, September.
    3. Hans B. Christensen & Valeri V. Nikolaev & Regina Wittenberg‐Moerman, 2016. "Accounting Information in Financial Contracting: The Incomplete Contract Theory Perspective," Journal of Accounting Research, Wiley Blackwell, vol. 54(2), pages 397-435, May.
    4. Gao, Pingyang, 2013. "A measurement approach to conservatism and earnings management," Journal of Accounting and Economics, Elsevier, vol. 55(2), pages 251-268.
    5. Ningzhong Li, 2010. "Negotiated Measurement Rules in Debt Contracts," Journal of Accounting Research, Wiley Blackwell, vol. 48(5), pages 1103-1144, December.
    6. Ningzhong Li, 2016. "Performance Measures in Earnings‐Based Financial Covenants in Debt Contracts," Journal of Accounting Research, Wiley Blackwell, vol. 54(4), pages 1149-1186, September.
    7. Igor Goncharov & Martin Jacob, 2014. "Why Do Countries Mandate Accrual Accounting for Tax Purposes?," Journal of Accounting Research, Wiley Blackwell, vol. 52(5), pages 1127-1163, December.
    8. Hakim Lyngstad{aa}s & Johannes Mauritzen, 2023. "Adults in the room? The auditor and dividends in small firms: Evidence from a natural experiment," Papers 2301.11079, arXiv.org.
    9. Andreas Haake, 2012. "Die Grundregeln von Herbert Hax zur Performance-Messung und die Bilanzierung von Kreditrisiken," Schmalenbach Journal of Business Research, Springer, vol. 64(1), pages 71-110, February.
    10. Stefan Wielenberg, 2009. "Ausschüttungsbegrenzung und liquidationsfinanzierte Ausschüttungen — wie sinnvoll ist vorsichtige Rechnungslegung?," Schmalenbach Journal of Business Research, Springer, vol. 61(1), pages 2-21, February.
    11. Jagadison K. Aier & Long Chen & Mikhail Pevzner, 2014. "Debtholders’ Demand for Conservatism: Evidence from Changes in Directors’ Fiduciary Duties," Journal of Accounting Research, Wiley Blackwell, vol. 52(5), pages 993-1027, December.
    12. John Armour, 2006. "Legal capital: an outdated concept," Working Papers wp320, Centre for Business Research, University of Cambridge.

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