Download this Paper Open PDF in Browser

Real Effects of Auditor Conservatism

55 Pages Posted: 27 Jun 2016 Last revised: 5 Oct 2017

Mahfuz Chy

University of Toronto, Rotman School of Management, Students

Ole-Kristian Hope

University of Toronto - Rotman School of Management

Date Written: September 5, 2017

Abstract

In this study, we exploit exogenous variations in auditor conservatism arising from staggered changes in state-level auditor legal liability and examine whether an increase in auditor conservatism leads to adverse real effects. We hypothesize that conservative auditors constrain managerial ability to meet earnings thresholds and that managers in turn resort to real earnings management. Using a difference-in-differences regression approach with firm fixed effects and a neighboring-state matched-sample design, we find evidence that an increase in auditor conservatism induces managers to engage in greater myopic R&D underinvestment as well as other forms of real activities manipulations in an attempt to meet earnings thresholds. Importantly, we find that the effect of auditor conservatism on myopic R&D underinvestment as well as other forms of real earnings management is greater when the ex-ante incentives to meet earnings thresholds are stronger. Our findings are robust to alternative explanations, changes in sample periods, alternative measures of innovation, and a battery of other sensitivity tests.

Keywords: Auditor conservatism; Auditor litigation; Innovation; Real effects; State liability laws; Patents; R&D; Going-concern opinions; Earnings management; Real earnings management

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

Suggested Citation

Chy, Mahfuz and Hope, Ole-Kristian, Real Effects of Auditor Conservatism (September 5, 2017). 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 Toronto, Rotman School of Management, Students ( email )

Toronto, ON
Canada

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

Paper statistics

Downloads
469
Rank
50,261
Abstract Views
1,694