Accounting conservatism and managerial incentives

Accounting conservatism and managerial incentives

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Article ID: iaor2008806
Country: United States
Volume: 51
Issue: 11
Start Page Number: 1626
End Page Number: 1632
Publication Date: Nov 2005
Journal: Management Science
Authors:
Keywords: accounting
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. 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 of Kwon et al. 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.

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