Trust, but Verify: Managerial Ability and Conditional Accounting Conservatism

Abstract

SYNOPSIS: High-ability managers' performance track records and "integrity" culture foster capital providers' trust and reduce career risks, allowing them to set the firm's financial reporting policies. Employing this discretion, highability managers are likely to report less conditionally conservative earnings. Data from S&P 1500 U.S. firms between 1996 and 2017 support this conjecture. Additional analysis continues to suggest that high-ability managers lower conditional accounting conservatism under limited boundary conditions. We also document that some highability managers misuse their financial reporting discretion opportunistically. Despite this, using a two-stage method, we show that our proposed theoretical mechanism-firms with a stronger corporate integrity culture, which promotes trust-enables high-ability managers to report less conditionally conservatively. This study contributes to the research on accounting conservatism and managerial behavior, cautioning capital providers against placing excessive trust in high-ability managers, as in some cases, that trust has been found to be misplaced.