Unconditional Accounting Conservatism & Efficient Contracting

Abstract: We examine how accounting conservatism affects contracting efficiency. More specifically, we examine the link between unconditional conservatism and accounting sensitivity in executive compensation contracts where we predict a negative relationship. We look at theoretical arguments of unconditional conservatism and how it affects gains recognition, noise in payoffs, and management possibilities for earnings management. We also consider the inverse relationship between conditional and unconditional conservatism. We conduct our study on Swedish listed firms between the years 2006 - 2016 by using an accrual based and a cash-flow to earnings-based proxy to measure unconditional conservatism. We find an inverse relationship suggesting that an increased degree of unconditional conservatism decrease contracting efficiency and accounting sensitivity in executive compensation contracts.