The Stewardship Role of Conservatism
36 Pages Posted: 28 Dec 2017
Date Written: December 15, 2017
We consider conservative reporting and investment decisions in the context of the hidden-information problem of unknown manager-type as well as the hidden-action problem of the diversion of resources. When either the hidden-information problem or the hidden-action problem exists, conservative reporting is not optimal. When both the hidden-information and hidden-action problems exist, conservative reporting is optimal for the high-productivity manager. Specifically, when conservatism is part of the high-productivity manager’s incentive package, it mitigates the problem of the diversion of resources by the low-productivity manager, and thus, is part of the stewardship role of accounting.
Keywords: adverse selection, tunneling, resource diversion, conservatism
JEL Classification: D82, D86, M41
Suggested Citation: Suggested Citation