Knowledge that Transforms

This paper uses a principal-agent model to study the interaction between hedging and earnings management. Hedging makes earnings management more difficult and they appear to be strategic substitutes in this model, which is both consistent with existing empirical evidence and provides a new explanation for that evidence. If hedging decision is contractible, hedging is efficient since it reduces both the risk premium and the equilibrium amount of earnings management. If hedging decision is not contractible, however, hedging does not always alleviate the agency problem. Surprisingly, sometimes a scenario of no hedging but allowing earnings management is efficient. The reason is that motivating hedging may require a more costly compensation scheme to mitigate the appeal of earnings management. In addition, this paper shows that tolerating some earnings management is always efficient when there is no hedge option, since it is costly to eliminate earnings management. Sometimes it is inefficient to take any action against earnings management. However, with the encouraged hedge option, the cost to eliminate earnings management can be reduced significantly and zero tolerance of earnings management may be efficient.

This paper analyzes the association between ownership, top management incentives, and expenditures on accounting information. We argue that organizations with privately appointed boards of directors such as for-profit and non-governmental nonprofit organizations use incentive pay practices which encourage managers to use accounting information to improve performance. In contrast, government organizations are publicly governed and are constrained in their compensation practices because hospital CEOs are administrators of government provided services. However, these hospitals must prove their efficiency to continue to receive adequate budgetary funding. Therefore government hospitals are more likely to use accounting information to gain legitimacy with stakeholders and regulators. Accordingly, we predict a positive relationship between expenditures on accounting information and contracting intensity in privately governed organizations, whereas we expect no such association for publicly governed organizations. We analyze data from California hospitals to determine differences in these roles across ownership types. We find a positive association between contracting intensity and expenditures on accounting information in privately governed hospitals, but no relation in publicly governed hospitals. Finally, we find differences in the use of accounting information within the privately governed hospitals, based on ownership. While for-profit hospitals expend resources on accounting information that helps improve their revenue positions, nonprofit hospitals expend resources on accounting information that facilitates decision-making related to operating efficiency and cost containment.