HEC Research Papers Series,
HEC Paris

Abstract: This article aims to clarify the consequences of accounting conservatism from a stewardship (principal-agent) point of view. Prior literature argues that the limited liability of the agent always results in a demand for conservatism, and that conservatism is beneficial because it deters earnings management. I challenge both arguments. Firstly, I show and derive the conditions under which an aggressive (or liberal) accounting information system might be preferred to a conservative one when the agent has limited liability. Risk aversion plays a crucial role, with a higher degree of risk aversion encouraging increased aggressiveness. Secondly, I provide the stylized example of choosing between rules-based (Rules ) and principles-based (Principles ) accounting. The latter, involving greater subjectivity, might increase the likelihood of earnings manipulation, but enables the agent to communicate relevant, albeit self-serving, private information. Both effects result in Principles being less conservative than Rules. I show that Principles might, nonetheless, be optimal, depending on the value of the likelihood ratio of manipulation versus the provision of relevant information. Manipulation and self-serving reports, which introduce an aggressive bias, might be the price to pay for more informative accounts.

Keywords: Earnings management; Accounting conservatism; Limited liability; Ranking of accounting information systems; Principal Agent

JEL-codes: D82; M41; M52

35 pages, June 15, 2016

Full text files

papers.cfm?abstract_id=2463424  

Download statistics

• HEC Paris
• Ordering Working Papers
• Home page for this series

Questions (including download problems) about the papers in this series should be directed to Antoine Haldemann ()
Report other problems with accessing this service to Sune Karlsson ().

This page generated on 2024-02-05 15:47:25.