Managerial Myopia and the Unintended Real Consequences of Conditional Conservatism

We examine whether the demand for conditional conservatism produces unintended real consequences that are exacerbated by managerial incentives to report higher earnings. We document a robust positive association between conditional conservatism and real earnings management (REM), particularly for firms whose CEOs face greater compensation incentives and capital market incentives to report higher earnings. Using mediation analyses, we find that conservatism has a negative indirect relation with future returns via REM over the next one to three years. In additional tests, we find that board independence attenuates the relation between conservatism and REM and that the relation is negative for firms with higher debt-to-equity. This latter finding suggests that firms with higher debtholder demands for timely loss recognition face less pressure to offset conditional conservative reporting by engaging in REM. Our findings suggest that, in contrast to its monitoring benefit, conditional conservatism can exacerbate managerial myopia, resulting in negative consequences for future firm value