ABSTRACT
WATTS & ZIMMERMAN set out to predict and explain the accounting choices made by companies rather than to deal specifically with issues of creative accounting. Accounting numbers may be incorporated into contracts in an attempt to align the interests of the contracting parties. Such contracts, however, may not be effective in aligning interests if company managers have discretion over the way in which the accounting numbers are constructed. Watts & Zimmerman, who assume that managers will generally be opportunistic in exercising discretion, look specifically to three areas in explaining accounting choice: compensation contracts, debt covenants, and political costs.
