Investigating the Impact of Managers’ Ability on Conservatism with a Focus on the Size and Leverage of Firms

Document Type : Research Paper

Authors

1 Prof., Department of Accounting, Faculty of Economics Management & Social Sciences, Shiraz University, Shiraz, Iran.

2 MSc., Department of Accounting, Kar Higher Education Institute, Qazvin, Iran.

3 Assistant Prof., Department of Accounting, Persian Gulf University, Bushehr, Iran.

Abstract

Objective: Managers' efficiency in using corporate resources is reflected in the information presented in the financial reports. The conservatism level in preparing financial reports is a criterion through which the quality of financial reporting can be measured. Managers can have conservative or less conservative (progressive) reporting based on ability according to the authority assigned to them and based on the theoretical framework of financial standards. Research has shown that if other factors remain stable, capable managers adopt conservative reporting by meeting the expectations of stakeholders and improving the firm's performance. That is because firms with high accounting conservatism are faced with fewer regulatory constraints, better internal governance quality, efficient contract utilization, minimization of agency costs, and minimization of taxes or legal costs. Since high-ability managers have unique skills and expertise to improve firm performance, negotiate auction deals in a better way, and more precisely estimate the variation in future firm performance, they can predict future losses better and incorporate to a timely reporting. However, the use of conservatism also depends on factors such as the size of the firm or the amount of financial leverage. This is because the level of complexity of the firm can be one of the most important factors in the managers' election. Therefore, deciding the level of conservatism may be a result of the size of the firm or the amount of its financial leverage rather than the ability of the management. In larger firms, disclosure of the information is more, and as a result information asymmetry is less. These firms have lower tax and legal demands and more regularity and uniformity and debt contracts usually include precise conditions, the violation of which leads to the imposition of costs on the firm, and after that managers with a high ability to serve the interests of the company apply lower levels of conservatism in large and leveraged firms. Therefore, firm size and financial leverage can moderate the relationship between managers' ability and conservatism. According to this, the main goal of this research is to examine managerial ability effects on conservatism emphasizing the role of firm size and financial leverage in Tehran Stock Exchange listed companies.
Methods: The research hypotheses, made using 125 firms in six years from 2015 to 2020, were statistically tested based on multivariate regression models. To measure the ability of the management, the model of Demerjian et al. (2012) and the firm's adjusted performance industry considering were utilized. Conservatism was calculated based on accrual and market criteria.
Results: The results indicated that along with any increase in managerial ability, the extent of conservatism increases as well. Moreover, managers with high ability employ lower levels of conservatism in large and leveraged firms.
Conclusion: The achieved findings indicated that high-ability managers apply conservatism to benefit firms and their stakeholders. First, capable managers use their unique skills and expertise to report conservatively based on efficient contracts. Second, they apply conservatism to prevent some consequences such as losing reputation and future jobs. In addition, decision-making about conservatism depends not only on managerial ability but also on organizational characteristics. Therefore, the influential factors of size and financial leverage must be considered by investors, creditors, auditors and other stakeholders in assessing managerial ability along with assessing the level of conservatism in financial statements or while making efficient contractual arrangements with managers’.

Keywords

References

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Accounting and Auditing Review
Volume 29, Issue 4
2023
Pages 628-649

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