On the relation between conservatism in accounting standards and incentives for earnings management

Journal Article (Journal Article)

This paper studies the role of conservative accounting standards in alleviating rational yet dysfunctional unobservable earnings manipulation. We show that when accounting numbers serve both the valuation role (in which potential investors use accounting reports to assess a firm's expected future payoff) and the stewardship role (in which current shareholders rely on the same reports to monitor their risk-averse manager), current firm owners have incentives to engage in earnings management. Such manipulation reduces accounting numbers' stewardship value and leads to inferior risk sharing. We then show that risk sharing, and hence contract efficiency, can be improved under a conservative accounting standard where, absent earnings management, accounting earnings represent true economic earnings with a downward bias, compared with under an unbiased standard where, absent earnings management, accounting earnings represent true economic earnings without bias. Copyright ©, University of Chicago.

Full Text

Duke Authors

Cited Authors

  • Qi, C; Hemmer, T; Yun, Z

Published Date

  • June 1, 2007

Published In

Volume / Issue

  • 45 / 3

Start / End Page

  • 541 - 565

Electronic International Standard Serial Number (EISSN)

  • 1475-679X

International Standard Serial Number (ISSN)

  • 0021-8456

Digital Object Identifier (DOI)

  • 10.1111/j.1475-679X.2007.00243.x

Citation Source

  • Scopus