Accounting Conservatism and Board Efficiency
Yanmin Gao, Alfred Wagenhofer, University of Graz, Austria
18th Mar 2014 11:30 am - Boardroom, Darlington Centre
This paper establishes a positive relation between board efficiency and conservative accounting. With that, it provides a theoretical underpinning for empirical studies that find a positive association between strong corporate governance and conservatism. Our model includes a board that has a monitoring and an advisory role and decides to retain or replace the incumbent manager based on accounting information. The optimal decisions trade off the cost of monitoring and the cost of replacing the manager. Conservatism is desirable because it makes monitoring more effective, but only if the board can monitor efficiently. We also find that earnings management tends to undo the benefit of conservative accounting and show the interaction between board composition and conservatism. We derive empirical predictions and discuss several extensions of the model.