Law Commons^™

Financial Accounting And Corporate Behavior, David I. Walker

Washington and Lee Law Review

The power of financial accounting to shape corporate behavior is underappreciated. Advocates of positive accounting theory have argued that even cosmetic changes in reported earnings can affect share value, not because market participants are unable to see through such changes to the underlying fundamentals, but because of implicit or explicit contracts that are based on reported earnings and transaction costs. However, agency theory suggests that accounting choices and corporate responses to accounting standard changes will not necessarily be those that maximize share value. For a number of reasons, including the fact that executive compensation is often tied to reported earnings, …