Do Conservative Auditors Induce Myopic Underinvestment in R&D?

55 Pages Posted: 27 Jun 2016 Last revised: 1 Dec 2016

Mahfuz Chy

University of Toronto, Rotman School of Management, Students

Ole-Kristian Hope

University of Toronto - Rotman School of Management

Date Written: November 30, 2016

Abstract

In this study, we exploit plausibly exogenous variations in auditor conservatism to examine whether an increase in auditor conservatism induces managerial myopia as manifested in R&D underinvestment. We hypothesize that conservative auditors constrain managerial ability to meet earnings thresholds; managers in turn potentially resort to real earnings management by cutting R&D investments. Consequently, auditor conservatism could induce myopic underinvestment in R&D and lead to a decline in client innovation as measured by patent-based metrics. Using a difference-in-differences regression approach with firm fixed effects, we find evidence consistent with this hypothesis. Our findings are robust to alternative explanations, changes in sample periods, alternative measures of innovation and a battery of other sensitivity tests. Collectively, the evidence suggests that regulation-induced auditor conservatism leads to an important negative externality in the form of managerial myopia.

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, Do Conservative Auditors Induce Myopic Underinvestment in R&D? (November 30, 2016). Rotman School of Management Working Paper No. 2801183. Available at SSRN: https://ssrn.com/abstract=2801183 or http://dx.doi.org/10.2139/ssrn.2801183

Mahfuz R 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
Canada

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

Paper statistics

Downloads
299
Rank
79,756
Abstract Views
1,022