Growth and Accounting Choice

Abstract:     
We investigate for a positive relation between growth and the aggressiveness of accounting choices. Our motivation is that this relation is an unexamined and very general implication from most existing theories and types of aggressive accounting choice. Note that the firms' decision to use aggressive choices is a function of two factors: specific motivations to increase earning like maximizing compensation, and the ability to increase earnings, which is captured by growth. For example, choice of straight-line vs. accelerated depreciation method has no income effect on no-growth firms and has an income-increasing effect on growth firms, so assuming aggressive reporting motivations exist, growth firms should have higher propensity to use straight line depreciation. Since growth captures the ability to increase income, holding other factors constant, a ranking on growth provides a clean ranking on the incentives to use income-increasing choices. Note that this intuition is extremely general and applies to almost all conceivable theories and types of aggressive accounting choice. Thus, a ranking on growth can be used as a powerful lens that summarizes the economic importance of many disparate accounting theories and settings of aggressive choice. Our empirical tests use a large sample of 260,000 observations over the last 50 years and a wide set of 9 accounting choices to provide a comprehensive investigation of the hypothesized relation. Our results are as follows. First, our main finding is that there is essentially no reliable relation between growth and aggressive accounting choice. A number of additional specifications and sensitivity analyses confirm this main finding. Second, changes in accounting choice are rare, which implies that accounting choice looks like a blunt and unwieldy instrument to achieve aggressive accounting objectives. Third, there is no reliable positive correlation between the aggressiveness of individual accounting choices, which implies that companies make no concerted efforts to increase income over the available set of accounting choices. Our main conclusion from these findings is that visible and long-term accounting choices are seldom used for achieving income-increasing objectives.

Keywords: Growth, accounting choice

JEL Classifications: M41, M43, M44

Working Paper Series