Managerial Horizons, Accounting Choices and Informativeness of Earnings

Abstract

Prior research has demonstrated that in companies with low managerial ownership managers exploit the latitude available in generally accepted accounting principles to alleviate contractual constraints, presumably to ensure job preservation (annual salary) and maximize incentive compensation (annual bonus). The result is accounting information that is less informative in low managerial ownership companies compared to companies with higher levels of managerial ownership. We hypothesize that in companies with low managerial ownership, higher levels of stock ownership relative to annual salary and bonus (i.e., the ratio of the market value of managerial ownership to annual compensation) mitigate managerial incentives to exploit accounting choices. Our findings are consistent with this hypothesis and suggest that greater managerial wealth tied to the long-term performance of the company through stock ownership versus short-term performance horizons (annual salary and bonus) results in more informative accounting earnings and lower discretionary accounting accrual adjustments in low managerial ownership companies.