Does accounting conservatism pay?

Raghavan J. Iyengar · Ernest M. Zampelli

49 citations0/0 files storedAccounting and Finance

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Auditing, Earnings Management, Governance Corporate Finance and Governance Accounting and Organizational Management

Abstract

Abstract We investigate whether or not there is a link between conservative accounting practices and the sensitivity of executive pay to accounting performance. Using several accrual‐based measures of accounting conservatism as well as alternative measures of accounting performance, we estimate an econometric model of CEO compensation that incorporates the interaction of accounting conservatism and accounting performance. Consistent with optimal contracting theory, we find that the sensitivity of executive pay to accounting performance is higher for firms that report conservative accounting earnings. These results support the hypothesis that accounting conservatism, by limiting earnings management opportunities and improving the reliability of accounting performance measures, allows firms to formulate contracts that tie executive compensation more closely to accounting performance.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1991Earnings Management During Import Relief Investigations 1979Moral Hazard and Observability 1995Detecting Earnings Management.1997The conservatism principle and the asymmetric timeliness of earnings1 2012Detecting Earnings Management 1994Debt covenant violation and manipulation of accruals 2003Conservatism in Accounting Part I: Explanations and Implications

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