Standard precision and aggressive financial reporting: the influence of incentive horizon

Abstract

The extant literature on precision in accounting standards suggests that financial statement preparers are less likely to make aggressive financial reporting decisions under less precise, principles-based accounting standards as compared to under more precise, rules-based accounting standards. We extend this line of research by examining how the incentive horizon of financial statement preparers influences earnings management behaviour. Consistent with prior literature, we find evidence that more precise standards lead to more income-increasing earnings management behaviour than do less precise standards when the incentive horizon is short-term in nature. However, when the incentive horizon is long-term, more precise standards are associated with financial reporting decisions that reduce current income relative to less precise standards. Importantly, the findings demonstrate that the effects of standard precision are changed by the incentive time horizon, and the effects of standard precision on financial decision makers cannot be fully understood when precision is studied without considering the timing of management incentive structures.