Accounting Discretion, Corporate Governance and Firm Performance

Posted: 15 Oct 2007

See all articles by Robert M. Bowen

Robert M. Bowen

Univeristy of San Diego - School of Business; University of Washington - Foster School of Business; University of San Diego - Department of Accountancy

Shivaram Rajgopal

Columbia Business School

Mohan Venkatachalam

Duke University - Fuqua School of Business

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Abstract

We investigate whether accounting discretion is (i) abused by opportunistic managers who exploit lax governance structures, or (ii) used by managers in a manner consistent with efficient contracting and shareholder value-maximization. Prior research documents an association between accounting discretion and poor governance quality and concludes that such evidence is consistent with abuse of the latitude allowed by accounting rules. We argue that this interpretation may be premature because, if such association is indeed evidence of opportunism, we ought to observe subsequent poor performance, ceteris paribus.

We conduct our analysis in two stages. In the first stage, we extend the prior literature and again find a link between poor governance and managers' accounting discretion. However, in the second stage we fail to detect a negative association between accounting discretion attributable to poor governance and subsequent firm performance. This suggests that, on average, in our relatively large sample, managers do not abuse accounting discretion at the expense of firms' shareholders. Rather, we find some evidence that discretion due to poor governance is positively associated with future operating cash flows and ROA, which suggests that shareholders may benefit from earnings management, perhaps because it signals future performance.

Keywords: Accounting discretion, earnings smoothing, abnormal accruals, corporate governance

JEL Classification: M41, M43, G34

Suggested Citation

Bowen, Robert M. and Rajgopal, Shivaram and Venkatachalam, Mohan, Accounting Discretion, Corporate Governance and Firm Performance. Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1021080

Robert M. Bowen

Univeristy of San Diego - School of Business ( email )

5998 Alcala Park
San Diego, CA 92110-2492
United States

HOME PAGE: http://https://www.sandiego.edu/business/undergraduate/accountancy/biography.php?profile_id=1799

University of Washington - Foster School of Business ( email )

Box 353226
University of Washington
Seattle, WA 98195-3226
United States

HOME PAGE: http://https://foster.uw.edu/faculty-research/directory/robert-bowen/

University of San Diego - Department of Accountancy ( email )

223 Olin Hall
5998 Alcalá Park
San Diego, CA 92110
United States
619.260.2385 (Phone)

HOME PAGE: http://www.sandiego.edu/business/directory/biography.php?id=1232

Shivaram Rajgopal (Contact Author)

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Mohan Venkatachalam

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7859 (Phone)
919-660-7971 (Fax)

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