The Financial Reporting Consequences of Proximity to Political Power

45 Pages Posted: 15 May 2015 Last revised: 11 Jun 2019

See all articles by Christian Gross

Christian Gross

University of Graz

Roland Koenigsgruber

SKEMA Business School

Christos Pantzalis

University of South Florida

Pietro Perotti

University of Bath - School of Management

Date Written: June 23, 2016

Abstract

In this study, we apply a new concept, corporate proximity to political power, to accounting research and examine its consequences on corporate financial reporting. Prior literature shows that higher proximity to political power leads to higher policy risk, i.e., uncertainty regarding the impact of future administration policies on the cash flow of the firm. An increase in policy risk implies an increase in the opaqueness of the information environment and in the expected volatility of future operating profitability; we argue that these effects both encourage and facilitate earnings management. Drawing on recent research in finance and political science, we use a measure of the alignment along party lines between politicians elected at the state level and the federally elected President as our main measure of proximity to political power. We find a significant positive association between the political alignment of firms’ home states and their level of absolute discretionary accruals. Consistent with the idea that firms engage in corporate political activities (lobbying and financial contributions) to hedge against policy risk, our results only hold for firms not engaging in such activities.

Keywords: earnings management, proximity to political power, political alignment, empirical financial accounting

JEL Classification: M41, M48

Suggested Citation

Gross, Christian and Koenigsgruber, Roland and Pantzalis, Christos and Perotti, Pietro, The Financial Reporting Consequences of Proximity to Political Power (June 23, 2016). Gross, C., Königsgruber, R., Pantzalis, C., & Perotti, P. (2016). The financial reporting consequences of proximity to political power. Journal of Accounting and Public Policy, 35(6), 609-634.. Available at SSRN: https://ssrn.com/abstract=2605878 or http://dx.doi.org/10.2139/ssrn.2605878

Christian Gross

University of Graz ( email )

Universitaetsstrasse 15 / FE
A-8010 Graz, 8010
Austria

Roland Koenigsgruber (Contact Author)

SKEMA Business School ( email )

Lille
France

Christos Pantzalis

University of South Florida ( email )

Tampa, FL 33620-5500
United States
(813) 974-3262 (Phone)

Pietro Perotti

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

HOME PAGE: http://www.bath.ac.uk/management/faculty/pietro-perotti.html

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