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Accounting Conservatism and Managerial Incentives

Author

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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
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    File URL: http://dx.doi.org/10.1287/mnsc.1050.0417
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    References listed on IDEAS

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    1. repec:bla:joares:v:15:y:1977:i:1:p:42-70 is not listed on IDEAS
    2. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    3. Richard A. Lambert, 1986. "Executive Effort and Selection of Risky Projects," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 77-88, Spring.
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    5. Hao Li, 2001. "A Theory of Conservatism," Journal of Political Economy, University of Chicago Press, vol. 109(3), pages 617-636, June.
    6. Basu, Sudipta, 1997. "The conservatism principle and the asymmetric timeliness of earnings," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 3-37, December.
    7. Zhang, Xiao-Jun, 2000. "Conservative accounting and equity valuation," Journal of Accounting and Economics, Elsevier, vol. 29(1), pages 125-149, February.
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    9. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    10. Harris, Milton & Raviv, Artur, 1979. "Optimal incentive contracts with imperfect information," Journal of Economic Theory, Elsevier, vol. 20(2), pages 231-259, April.
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    Citations

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    Cited by:

    1. 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.
    2. Chen, Hui & Jorgensen, Bjorn, 2018. "Market exit through divestment: the effect of accounting bias on competition," LSE Research Online Documents on Economics 64217, London School of Economics and Political Science, LSE Library.
    3. FU, Qiang & LI, Ming, 2010. "Policy Making with Reputation Concerns," Cahiers de recherche 09-2010, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    4. 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.
    5. 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.
    6. Fu, Qiang & Li, Ming, 2014. "Reputation-concerned policy makers and institutional status quo bias," Journal of Public Economics, Elsevier, vol. 110(C), pages 15-25.

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