Corporate governance, conservatism and the agency problem

This dissertation investigates the relationship between corporate governance mechanisms and conservatism and its implications for firms' financial reporting behavior. Both corporate governance and conservatism serve to reduce the problems that arise from the separation of ownership and control in corporations. While prior research has focused on corporate governance mechanisms, and separately on conservatism, it has ignored how corporate governance and conservatism relate to each other and how they impact firms' reporting behavior. This dissertation attempts to fill that gap by investigating this relationship and studying its implications for research, practice and policy.;The central thesis in this dissertation is that incentive alignment is a key construct in understanding the relationship between corporate governance, conservatism, and financial reporting behavior. Traditionally, strong corporate governance mechanisms have been shown to induce higher conditional conservatism. I argue that this relationship is modified by the level of incentive alignment. I find that as the level of incentive alignment increases, conservatism is lower. Specifically, I hypothesize and find that greater incentive alignment is associated with (a) lower conditional conservatism, (b) higher earnings response coefficients and (c) higher earnings quality. My analysis does not find consistent directional and significant support for the hypothesis that firms with less incentive alignment engage in opportunistic earnings management. These findings are in line with recent findings by Lara et al. (2007) and Bowen et al. (2007) who posit that on average lax governance mechanisms are not associated with instances of managers abusing accounting discretion at the expense of the firm's shareholders.;The research findings suggest that selective strengthening of corporate governance and selective adoption of conservative reporting for low incentive aligned firms provide a cost-effective option for managing agency conflicts. These findings are relevant to the FASB's current debate on when and whether standards need to be conservative versus neutral.