The economic consequences of accounting choice implications of costly contracting and monitoring

Abstract

In this paper, we review research into the economic consequences of voluntary and mandatory choices of accounting techniques and standards. We discuss how the predictions of extant economic consequence theories are driven by contracting and monitoring costs associated with management compensation contracts, bond covenants, regulation, and/or political visibility. We review empirical tests of economic consequence theories, categorize those tests, and discuss their strengths and weaknesses. The empirical tests reveal two systematic associations with accounting choice: size, a proxy for political visibility, and leverage, a proxy for contracting and monitoring costs of lending agreements. Interpretation of the results is difficult, due to general limitations of the tests. We conclude by suggesting some directions for future research, based on our analysis of the potential payoffs associated with different types of empirical tests.