Real Effects of Auditor Conservatism

62 Pages Posted: 27 Jun 2016 Last revised: 28 Feb 2019

See all articles by Mahfuz Chy

Mahfuz Chy

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business

Ole-Kristian Hope

University of Toronto - Rotman School of Management

Date Written: February 26, 2019

Abstract

We examine the effects of regulatory constraints on managerial discretion and managers’ resulting myopic decision. Specifically, we hypothesize that because conservative external auditors constrain income-increasing accounting discretion and thus reduce managers’ ability to meet short-term performance targets, managers may sacrifice long-term investments in innovation to boost current earnings. Using a difference-in-differences approach with staggered shocks and firm fixed effects, we find evidence consistent with this hypothesis. Cross-sectional analyses further reveal that increased auditor conservatism induces a stronger adverse effect on corporate innovation under circumstances where managers stand to lose the most from missing short-term performance targets. Our study highlights how auditors, as external monitors, can affect not only the financial reporting quality of their clients, they may also induce suboptimal alterations in their real operations. Collectively, the evidence implies that regulatory constraints on managers’ accounting discretion can lead to adverse real effects.

Keywords: Innovation; Patents; Citations; R&D; Short-termism; Auditor conservatism; Real effects; State legal liability laws; Financial reporting discretion; Going-concern opinions

JEL Classification: M41, O31, O32, G31, G38

Suggested Citation

Chy, Mahfuz and Hope, Ole-Kristian, Real Effects of Auditor Conservatism (February 26, 2019). Rotman School of Management Working Paper No. 2801183; 28th Annual Conference on Financial Economics and Accounting. Available at SSRN: https://ssrn.com/abstract=2801183 or http://dx.doi.org/10.2139/ssrn.2801183

Mahfuz Chy

University of Missouri at Columbia - Robert J. Trulaske, Sr. College of Business ( email )

331 Cornell Hall
Columbia, MO 65211
United States

Ole-Kristian Hope (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

HOME PAGE: http://www.rotman.utoronto.ca/FacultyAndResearch/Faculty/FacultyBios/Hope.aspx

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