The role of accounting conservatism in executive compensation contracts

Abstract

To test the implication of Watts’ (2003) argument that accounting conservatism increases the efficiency of executive compensation contracts, we investigate the relation between accounting conservatism and earnings‐based executive compensation contracts in Japanese firms. We focus on Japanese executive compensation practices because the demand for accounting conservatism is likely to be greater for Japanese than for US firms given the predominance of earnings‐based executive compensation contracts and relatively weak corporate governance of compensation contracts in Japan. We also investigate how the quality of the ex‐ante information environment affects the relation between accounting conservatism and earnings‐based executive compensation contracts. Consistent with our expectations, we find a positive relation between accounting conservatism and the compensation earnings coefficient. We also show that this positive relation is greater for firms with poor ex‐ante information environment. These results suggest that the demand for accounting conservatism is greater for firms that use more earnings‐based executive compensation contracts and have more serious ex‐post settling‐up problems.

The effects of accounting conservatism on executive compensation

“…Jeong and Kim (2013) found a positive relationship between equity-based compensation to outside directors and accounting conservatism using the US data between 2006 and 2008. Using the Japanese data, Iwasaki et al (2018) found a positive relationship between accounting conservatism and compensation.…”

“…Effects of accounting conservatism compensation to the outsider director, whereas, in our paper, the dependent variable is CEO compensation and the independent variable is accounting conservatism. Using the Japanese data, Iwasaki et al (2018) found a positive relationship between accounting conservatism and the compensation earnings coefficient. In their study, the dependent variable is accounting conservatism, and the independent variable is earnings-based compensation, which is different from us.…”

Board directors with foreign experience and stock price crash risk: Evidence from China

“…Huang et al. (), Iwasaki, Otomasa, Shiiba, and Shuto (), and Brockman et al. () generally discuss the relation between incentives to be transparent with regard to information disclosure.…”

CEOs’ experience of the Great Chinese Famine and accounting conservatism

“…First, it provides evidence that directly identifies and quantifies the effects of traumatic experiences in the early life of CEOs on accounting conservatism. Prior studies show that firm‐level factors, such as firm characteristics, corporate governance and ownership structures (e.g., Bonetti, Ipino, & Parbonetti, 2017; Lara, Osma, & Penalva, 2009; Li & Xu, 2018; Watts, 2003; Xia & Zhu, 2009) as well as external factors such as contractual arrangements, litigation risk, taxation and regulation can help explain accounting conservatism (e.g., Bushman & Piotroski, 2006; Holthausen, 2003; Huijgen & Lubberink, 2005; Iwasaki, Otomasa, Shiiba, & Shuto, 2018; Khurana & Wang, 2015). However, these studies assume that executives are homogenous.…”