FINANCIAL ACCOUNTING AND CORPORATE BEHAVIOR|
David I. Walker
Boston University School of Law Working Paper 06-05
The power of financial accounting to shape corporate behavior is underappreciated.
Positive accounting theory teaches that even cosmetic changes in reported
earnings can affect share value, not because market participants are unable
to see through such changes to the underlying fundamentals, but because
of implicit or explicit contracts that are based on reported earnings
and transaction costs. However, agency theory suggests that accounting
choices and corporate responses to accounting standard changes will not
necessarily be those that maximize share value. For a number of reasons,
including the fact that executive compensation often is tied to reported
earnings, managerial preferences for high earnings generally will exceed
shareholder preferences, leading to share value reducing tradeoffs between
reported earnings and net cash flows. The empirical literature on the
details of positive accounting theory is mixed, but the evidence firmly
establishes the power of accounting to shape corporate behavior.
The power of accounting and the divergence of interests have many implications
for courts and policy makers. For example, consideration of proposals
to increase conformity between tax and financial accounting rules as a
means of combating tax sheltering and/or artificial earnings inflation
must take into account the incentive properties of accounting standards
and recognize that narrowing the gap between tax and book income will
have economic consequences, however the gap is narrowed. This Article
considers this and other implications of the behavioral effects of accounting
standards, including the possibility of setting accounting standards instrumentally
as a means of regulating corporate behavior, an alternative to tax incentives,
mandates, or direct subsidies.
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David I. Walker Contact Information
Boston University School of Law
765 Commonwealth Ave
Boston, MA 02215
Presentation and Publication Information:
To be announced.
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