Real Effects of Auditor Conservatism
55 Pages Posted: 27 Jun 2016 Last revised: 23 Mar 2018
Date Written: March 20, 2018
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: Suggested Citation