Local Political Corruption and Financial Reporting Conservatism

Abstract

We document that firms in more politically corrupt regions of China adopt more conservative accounting. The relation between local political corruption and accounting conservatism weakens after China’s anti-corruption campaign launched in 2012 and in firms with a lower risk of expropriation by corrupt officials, stronger incentives to report earnings aggressively, or greater gains from corruption. Further analysis shows that accounting conservatism and alternative corporate strategies complement each other in shielding firms against corrupt officials’ expropriation of corporate resources. Our study provides novel evidence about an accounting approach used by firms in response to perceived political costs.

Keywords: Political Corruption, Anti-corruption Campaign, Accounting Conservatism, Political Costs, Financial Reporting, Corporate Shielding Strategy

JEL Classification: D22, D72, D73, M41