Real Effects of Auditor Conservatism

55 Pages Posted: 27 Jun 2016 Last revised: 29 Aug 2018

Mahfuz Chy

University of Missouri at Columbia

Ole-Kristian Hope

University of Toronto - Rotman School of Management

Date Written: August 29, 2018

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 (August 29, 2018). 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 ( email )

332 Cornell Hall
Columbia, MO Columbia 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

Register to save articles to
your library

Register

Paper statistics

Downloads
652
rank
36,033
Abstract Views
2,414
PlumX