Abstract

http://ssrn.com/abstract=249437
 
 

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The Role of Accrual Accounting in Restricting Dividends to Shareholders


Christian Leuz


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network


European Accounting Review, 1998, Vol. 7, pp. 579-604

Abstract:     
This paper addresses the question why net earnings and other accrual accounting numbers are frequently used to restrict dividends to shareholders. Even though this role of accrual accounting is widely accepted in the literature, a theory explaining the role of accruals in dividend restrictions is still in its early stages. Building on the principal-agent framework, I argue that basic features of the accrual process can be viewed as arising from the demand for dividend restrictions mitigating debt-related incentive problems. This explanation is consistent with the observation that, historically, debt contracting, dividend restrictions and the development of accrual accounting have been closely related. The basic idea is that the use of transactions and events in the accrual process leads to a contingent formulation of the upper bound on dividends in an earnings-based constraint. Transactions and events act as imperfect, but verifiable indicators for (unverifiable) determinants of debt-related incentive problems. In particular, by shifting cash flows through time, e.g. with provisions or depreciation charges, the accrual process can mitigate distortions in shareholders' investment decisions that regularly arise in a multi-period context. Several examples illustrating this are provided. Although the accrual process is not the only way to mitigate these distortions, an equivalent cash-based constraint requires a complex menu of payout parameters. Such a menu is generally not observed in practice.

JEL Classification: G35, M41, D23

Accepted Paper Series





Not Available For Download

Date posted: November 9, 2000  

Suggested Citation

Leuz, Christian, The Role of Accrual Accounting in Restricting Dividends to Shareholders. European Accounting Review, 1998, Vol. 7, pp. 579-604. Available at SSRN: http://ssrn.com/abstract=249437

Contact Information

Christian Leuz (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-1996 (Phone)
HOME PAGE: http://chicagobooth.edu/fac/christian.leuz
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
HOME PAGE: http://www.nber.org
European Corporate Governance Institute (ECGI)
Brussels
Belgium
HOME PAGE: http://www.ecgi.org
Center for Financial Studies (CFS) ( email )
Grüneburgplatz 1
Frankfurt am Main, 60323
Germany
University of Pennsylvania - Wharton Financial Institutions Center
3641 Locust Walk
Philadelphia, PA 19104-6218
United States
CESifo Research Network
Poschinger Str. 5
Munich, DE-81679
Germany
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