In our article recently published in the European Accounting Review, Phong Ngo and I investigate whether and how the uncertainty arising from the political process can influence corporate accounting policies. We focus on the impact of the U.S. gubernatorial elections on managers’ conservative accounting decisions. The extant literature has documented that accounting conservatism, which makes bad news reflected in earnings more timely than good news, can facilitate the contracting process and mitigate agency costs due to the information asymmetry between firms and their contracting parties. Prior studies have shown that political uncertainty can impact managerial decisions such as initial public offering, mergers and acquisitions, and voluntary disclosures. However, whether politics can alter the nature of conservative accounting in mandatory disclosures remains an open question.
Our study examines a sample of more than 19 thousand U.S. firms over the period 1963-2016, covering 699 U.S. gubernatorial elections. We find that in the year leading up to an election when political uncertainty arises, accounting conservatism increases by 17 percent relative to other years. Further analyses suggest that this finding is driven by increased demand for accounting conservatism from firms’ contracting parties. For example, the results indicate that the political uncertainty effect on conservatism is more pronounced for firms with greater industry exposures to contracting needs, and for firms with higher leverage and lower managerial ownership. This is because the rising political uncertainty makes the contracting parties less informed about the changes and implications of future government policies after the elections, and thus demand more accounting conservatism as an efficient contracting technology to alleviate agency problems.
This paper adds to the literature in three ways. First, we contribute to the research on accounting conservatism by using an exogenous increase in information asymmetry during election periods to identify a causal impact of information asymmetry on conservative reporting. Second, our paper contributes to an emerging stream of literature investigating the impact of political uncertainty on corporate policies by documenting that accounting conservatism, one important financial reporting policy, is also shaped by political uncertainty. Third, our study sheds light on the role of political uncertainty in shaping the corporate information environment. We find that managers respond to the political uncertainty arising from electoral politics by providing more conservative financial reporting to enhance contracting efficiency.
To cite our article: Lili Dai, & Phong Ngo (2020): Political Uncertainty and Accounting Conservatism, European Accounting Review, DOI: 10.1080/09638180.2020.1760117