Evidence on the Role of Accounting Conservatism in Monitoring Managers’ Investment Decisions
Accounting and Finance, Forthcoming
Posted: 14 Jun 2010
Date Written: June 11, 2010
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.
Keywords: conservatism, corporate governance, agency costs
JEL Classification: G3, M41
Suggested Citation: Suggested Citation