Managerial Ability and Accounting Conservatism – US Evidence

In this study, we investigate whether the managerial ability is associated with accounting conservatism and how demand for accounting conservatism affects the association. While prior literature in the area of accounting conservatism has largely focused on firm-specific characteristics, we investigate manager-specific effects using the measure of managerial ability. Using a sample of US firms for the period of 1988-2019, we find that firms with high ability managers are less likely to use conservative accounting. More importantly, we show that the association becomes weaker when the usefulness of accounting conservatism is the most – i.e., when firms are highly leveraged. Overall, our result suggests that high ability managers are more likely to resolve uncertainty in their performance by their operational ability so that they have less incentive to use conservative accounting. In addition, although managerial ability could be a substitute for conservative accounting to some extent, conservatism is still a useful mechanism to alleviate information asymmetry, especially when demand for conservatism is higher. This paper shed new light on the role of managerial ability in the choice of the level of conservatism.