Intertemporal analyses of conservatism: From the perspectives of standard setters, managers and auditors

In the aftermath of recent accounting scandals, there is a renewed interest in conservatism. A deeper understanding of what gives rise to conservatism may help understand and improve current reporting practices. One important feature of conservatism is the intertemporal reversal effect, that is, conservative accounting practices shift income among periods. Few studies have considered this feature in the literature on conservatism. This dissertation rationalizes conservative accounting practices in multi-period settings where the intertemporal reversal effect is explicitly incorporated.; The demand for a conservative accounting system and the demand for managerial conservatism are explored. A conservative accounting system introduces systematic bias in accounting reports. In a two-period setting with moral hazard, the bias in the first period is the opposite of that in the second period in a probabilistic sense. A conservative accounting system arises endogenously as an efficient contracting mechanism with incentive spillover. In a two-period setting with hidden information and hidden action, managerial conservatism is interpreted as the manager's choice of an accounting method that keeps the first-period net income low. A conservative accounting method results in a lower first-period income and a higher second-period income. A piece-wise linear contract with accounting income as the performance measure is adopted. The manager chooses to defer his current compensation and makes a bet on the future when the future will be good, whereas the manager cannot afford to do this when the future will not be good. Managerial conservatism arises as an efficient "betting" mechanism for the manager to credibly communicate that the future will actually be good.; Both exercises indicate that under certain circumstances, conservatism serves as an efficient contracting mechanism even when taking into account the intertemporal reversal effect. Specifically, by deferring the manager's compensation, conservative accounting practices enable the manager to focus on the future. I conjecture that accounting numbers under conservative accounting practices would be more robust and result in less manipulative performance measures, the fact that should be considered in corporate governance issues.