Adverse public policy implications of the accounting conservatism doctrine: The case of premium rate regulation in the HMO industry

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Abstract

Evidence of managerial misrepresentation of performance through the choice of financial reporting methods is well-documented. The phenomenon has been studied primarily as overstatements of profit performance, with the presumed motivating factor the separation of ownership from managerial control. We examine in this paper evidence of managerial misrepresentation of performance designed to avert adverse political effects of excessive profitability. Specifically, we provide evidence of managerial earnings management designed to disguise above-normal rates of return in the politically-sensitive prepaid health care industry. This is achieved through the relative overstatement of incurred but not reported expenses by the consistently-profitable segment of the industry. To the extent that the accounting doctrine of conservatism might favor overestimation of potential liabilities, adverse public policy implications arise from that accounting convention.

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