RIEB Discussion Paper Series No.2012-08

Title

The Role of Accounting Conservatism in Executive Compensation Contracts

Abstract

In order to test the implication of Watts's (2003) argument that accounting conservatism can increase the efficiency of executive compensation contracts, we investigate the relationship between the adoption of accounting conservatism and the payment of excess executive compensation in Japanese firms. We focus on the executive compensation practice in Japan because the demand for accounting conservatism is likely to be larger for Japanese firms than it is for U.S. firms because of the lack of explicit compensation contracts in Japan. Consistent with the proposed arguments, we find that accounting conservatism is negatively related to excess cash compensation. We also find that this negative relationship is larger for firms with higher compensation earnings coefficients. These results suggest that the adoption of conservatism in accounting reduces the possibility of managers receiving excess cash compensation and that the demand for accounting conservatism in executive compensation contracts is larger when the ex post settling up problem is more serious.

Keywords

accounting conservatism; compensation contract; excess compensation; ex post settling up problem; implicit contract

JEL Classification

M41

Inquiries

Takuya IWASAKI
Kansai University
Faculty of Commerce, Japan

Shota OTOMASA
Kansai University
Faculty of Commerce, Japan

Atsushi SHIIBA
Osaka University
Graduate School of Economics, Japan

Akinobu SHUTO
Research Institute for Economics and Business Administration
Kobe University
Rokkodai-cho, Nada-ku, Kobe
657-8501 Japan
Phone: +81-78-803-7036
FAX: +81-78-803-7059