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Accounting Discretion and Managerial Conservatism: An Intertemporal Analysis

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  • Haijin Lin

Abstract

Accounting discretion and the principle of conservatism are two salient features embedded in financial reporting systems. Arguably, the practice of conservative accounting choices can never be well understood without incorporating their effect on future periods (the intertemporal effect). This paper provides one explanation for managerial conservatism in a two†period agency model with hidden information (a binary project type) and hidden actions (the agent's efforts). A piece†wise linear incentive scheme with accounting earnings as the performance measure is employed. The agent's discretion is the choice of a depreciation method. Discretion is valuable if and only if the agent's marginal productivity of a “bad†project is greater than that of a “good†project, but not to an extreme degree. A conservative depreciation method decreases current compensation in exchange for a “bet†on future compensation and, hence, serves as a commitment device for the agent to signal that the prospect is indeed good. The accounting mechanism replicates the performance of the optimal direct mechanism.

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  • Haijin Lin, 2006. "Accounting Discretion and Managerial Conservatism: An Intertemporal Analysis," Contemporary Accounting Research, John Wiley & Sons, vol. 23(4), pages 1017-1041, December.
    • Handle: RePEc:wly:coacre:v:23:y:2006:i:4:p:1017-1041
    DOI: 10.1506/0343-6720-V320-4730
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    2. Rahimah Mohamed Yunos Author_Email: rahim221@johor.uitm.edu.my & Malcolm Smith & Zubaidah Ismail & Syahrul Ahmar Ahmad, 2011. "Inside Concentrated Owners, Board Of Directors And Accounting Conservatism," Annual Summit on Business and Entrepreneurial Studies (ASBES 2011) Proceeding 2011-053-178, Conference Master Resources.
    3. Robert Gox & Alfred Wagenhofer, 2010. "Optimal Precision of Accounting Information in Debt Financing," European Accounting Review, Taylor & Francis Journals, vol. 19(3), pages 579-602.

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