Literature Review On Accounting Conservatism

The agency problems or conflicts are continuously happening between the principal and the agent. It particularly arises when an interest conflict occurs between the principal and the agent. In terms of finance, there are two core agency relationships; managers and stockholders and managers and creditors. To balance the interests and satisfactions between managers and stockholders which helps firm to improve performance, there are a variety of different measures have been generated and implemented by Telstra in order to optimize the bond and monitoring costs.

Corporate governance can address agency problems, they are the rules that dictate the company’s behavior towards it’s directors, managers, employees, shareholders, creditors, competitors and community.

2. A principal-agent relationships involves the owners (principals) delegating decision-making authority to managers (agents). A conflict occurs when the agents pursue acceptable levels of shareholder wealth and profit rather than a maximization of profit. They are pursuing their own self-interests. One way that the agents act in their own self-interests would be by focusing on long-term job security. This could cause the agents to limit the amount of risk taken by the firm. The firm may have an opportunity that is considered a riskier venture that could produce high profits if successful. If the venture proves to be unsuccessful, then the agent is at risk of dismissal. Therefore,

Our textbook defines an agency problem as a “conflict between the goals of a firm’s owners and its managers” (Megginson & Smart, 2009). It then defines agency costs as dollar costs that arise because of this conflict. In the corporate structure, stockholders are the owners of the firm, and they elect a board of directors to oversee the firm and help protect their investment. The board then hires the right corporate managers to run the firm with the goal of maximizing the wealth of the

To over view the knowledge we learnt from accounting theory and practice, the main thing I can conclude that is the tendency of accounting will shift away from technical way to people’s behaviour way. By understanding what should do, we should ask why and how we could improve and change it into a better way. This essay aims to explain how the theoretical material that we learn in lectures can be developed under a real practical manner.

Agency theory is a relationship that mostly rely on the agreement of which a party (agent) is going to act on the best interest of other parties (principal) (Michelson, 1995). Agency theory states that the agency relationship appears at the time when the principal recruit the agents to operate the business and make a decision (Jensen & Meckling, 1976). According to Tampubolon (2010), agency theory is typically found among the internal parties in whole level of management within the profit-oriented business because it assumes that the principal and agent are, similarly, economically rationale and have their own interest to maximize their wealth. However, due to the different interests, choice, and information, this agency relationship lead to the conflict of interests between the agent and principal. Principals are motivated to increase their welfare and profitability and pay less attention and reward to the agents’ effort and risk during the process to maximize the principals’ welfare. Agents also have their own interests to fulfill, or even maximize their need economically and psychologically. As the agents directly manage the business, they have more information of the business compare to the principals, which result in information asymmetry. Due to the information asymmetry, the agents have a likelihood to create an opportunity to maximize their own economical and psychological needs by doing some income smoothing (Hepworth, 1953).

The literature on conservatism accounting is very limited. Watts (2003), has suggested that conservatism is related to debt contracts, while Gjesdal & Antle (2001) suggest that conservatism is the interaction between income measurement and dividend covenants. Even though conservatism may be most favorable, the result derives from shareholders trading off cash flows in different periods, not from the need to protect the interests of creditors.

In the underlying paper the author re-examines the conservatism principle and its asymmetric effects on earnings. With samples consisting of all firm-year observations from 1963 to 1990 with returns data on the CRSP NYSE/AMEX Monthly files and respective accounting data on the COMPUSTAT Annual Industrial and Research files, he formulates and tests four major hypotheses to find evidence for his predictions. At first he chracterizes “conservatism in accounting as the more timely recognition in earnings of bad news regarding future cash flows than good news”.1 In his first hypothesis he predicts a more sensitive response of earnings towards bad news in comparison to good news, proxied by negative and positve annual stock returns. His second prediction is that earnings are more timely than cash flow, indicating a stronger association of accruals to conservative accounting effects. Hypotheses three and four account for a test on the

It has been become an issue of great concern that the accounting profession must find a common theory in order to address and put the issue at rest. This therefore, has called for the study of this topic under review “the demand for and supply of accounting theories: the market for excuses. As a result of this several questions have been raised. For instance, the question of why accounting theories are predominantly normative has been put forward by this article? Secondly, why no single theory in accounting profession that is generally or widely accepted? It has been argued that the financial accounting theories have been found to be ineffective most especially in the area of impacting accounting practice and policy, though, this has been

Agency problem is a potential conflict between the agent and shareholders in the interest. It is shown that ownership is separated from management. This cause not only is the divergence of ownership and control, but also the information is asymmetrical. When ownership is separated

positive accounting hypothesis (PAT) estimates that, in flawed markets, accounting decision may be controlled by directors looking to impact reported income and capital structure (Watts and Zimmerman, 1978). Specifically, the positive accounting hypothesis (PAT) contends that accounting decisions are liable to be spurred by components, for example, supervisors ' extra arranges, the company 's obligation/value proportions and the more extensive political impact of outsiders (Watts and Zimmerman, 1978; 1986).

To begin with, the agency problems exist because of the separation of ownership and control (Berk and DeMarzo, 2014). This separation leads to serious conflicts of interest: a player act based on its own interests at the expense of others ' (Jerzemowska, 2006). Jensen and Smith agree that there are two types of conflicts of interest: between shareholders and managers on one hand and between debt holders and shareholders on the other hand. Why, instead of align their interests to make the firm better off, each party try to act for its own interests?

As explained by Schelker (2013), the agency problem between the owners and the management of a firm is at the heart of the corporate governance literature. Hence, there is a need for a

“Agency theory is concerned with resolving two problems that can occur in agency relationships. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principal to verify what the agent is actually doing.”

Most of the literature on corporate governance finds its roots in agency theory the relationships normally occurs when the principal hires the agent to perform a service on the principals ' behalf. the decision making authority is delegated by the principal to the agent.However the relationship between the principal and the agent can not be as simple and smooth as it appears (Theory of Mallin, 2010).