Effects of Accounting Conservatism on Investment Efficiency and Innovation

51 Pages Posted: 19 May 2016 Last revised: 27 Nov 2019

See all articles by Volker Laux

Volker Laux

University of Texas at Austin - McCombs School of Business

Korok Ray

Texas A&M University - Mays Innovation Research Center

Date Written: November 25, 2019

Abstract

We study how biases in financial reporting affect managers' incentives to develop innovative projects and to make appropriate investment decisions. Conservative reporting practices impose stricter verification standards for recognizing good news, and reduce the chance that risky innovations will lead to favorable future earnings reports. Holding all else constant, more conservative reporting therefore weakens the manager's incentive to work on innovative ideas, consistent with informal arguments in the extant literature. However, all else does not stay constant because the manager's pay plan will change in response to changes in the accounting system. We show that under optimal contracting, more conservative accounting does not stifle innovation in organizations, but rather increases incentives for innovation, as long as conservatism reduces the risk of an overstatement.

Keywords: Optimal contracting, Innovation, Accounting conservatism, Investment efficiency

Suggested Citation

Laux, Volker and Ray, Korok, Effects of Accounting Conservatism on Investment Efficiency and Innovation (November 25, 2019). Mays Business School Research Paper No. 2781261. Available at SSRN: https://ssrn.com/abstract=2781261 or http://dx.doi.org/10.2139/ssrn.2781261

Volker Laux (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

2317 Speedway
Austin, TX 78712
United States

Korok Ray

Texas A&M University - Mays Innovation Research Center ( email )

4113 TAMU College State
TX 77843-4113
United States

HOME PAGE: http://mays.tamu.edu/directory/korok/

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