The Role of Accounting Conservatism in Executive Compensation Contracts
Journal of Business Finance and Accounting, Forthcoming
57 Pages Posted: 17 Mar 2012 Last revised: 5 Aug 2018
Date Written: July 1, 2018
To test the implication of Watts’ (2003) argument that accounting conservatism increases the efficiency of executive compensation contracts, we investigate the relationship between accounting conservatism and earnings-based executive compensation contracts in Japanese firms. We focus on Japanese executive compensation practices because the demand for accounting conservatism is likely to be larger for Japanese than U.S. firms because of the predominance of earnings-based executive compensation contracts and lack of explicit compensation contracts in Japan. Consistent with our arguments, we find a positive relationship between accounting conservatism and the compensation earnings coefficient. Furthermore, this positive relationship is greater for firms with poor ex-ante information environment. These results suggest that the demand for accounting conservatism is higher for firms that use more earnings-based executive compensation contracts and have more serious ex post settling up problems.
Keywords: accounting conservatism, compensation contract, compensation earnings coefficient, information environment, ex post settling up problem
JEL Classification: M41
Suggested Citation: Suggested Citation