The Stewardship Demand for Conditional Conservatism

• In Event: Analytical Models

Abstract

I investigate the properties of stewardship oriented accounting information systems when information is costly and financial reports generated by the system are susceptible to a certain degree of managerial manipulation. Following Shin (1994), I assume that managers can selectively suppress, but cannot credibly fabricate, private information generated by the accounting system. I show that the stewardship objective creates a demand for conditional conservatism that is increasing in the manager's ability to suppress bad news. In turn, conditional conservatism leads to a spike at zero in the distribution of earnings and to an S-shaped relationship between earnings and returns. I also illustrate how earnings become more predictable and less decision useful as the extent of conditional conservatism exhibited by the accounting system increases. Finally, I find that the optimal stewardship and decision usefulness oriented accounting information systems are identical when information is free; otherwise they tend to diverge. These results highlight the importance of identifying the benchmarks implied by different financial reporting objectives when making empirical inquiries.

Author

• Jonathan Bonham, Rice University