Evidence on the Role of Accounting Conservatism in Monitoring Managers' Investment Decisions
Anwer S. Ahmed
Texas A&M University - Mays Business School
Saint Louis University - Department of Accounting
June 1, 2010
Accounting and Finance, Forthcoming
Watts (2003), among others, argues that conservatism helps in corporate governance by mitigating agency problems associated with managers’ investment decisions. We hypothesize that if conservatism reduces managers’ ex ante incentives to take on negative NPV projects and improves the ex post monitoring of investments, firms with more conservative accounting ought to have higher future profitability and lower likelihood (and magnitude) of future special items charges. Consistent with this expectation, we find that firms with more conservative accounting have (i) higher future cash flows and gross margins, and (ii) lower likelihood and magnitude of special items charges than firms with less conservative accounting.
Number of Pages in PDF File: 41
Keywords: accounting conservatism, corporate governance, agency costs
JEL Classification: G31, G34, M41, M43, M44
Date posted: September 16, 2007 ; Last revised: June 11, 2010
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