Local Political Corruption and Financial Reporting Conservatism

Abstract

We examine the relation between local political corruption and firms’ financial reporting conservatism using provincial-level data on corruption in China. The results show that firms in more corrupt regions report more conservatively. In other words, firms in the more corruption-prone regions are more likely to speed the recognition of bad news and slow the recognition of good news in their reported earnings. Similar results are obtained when we use the recent anti-corruption campaign in China as a quasi-natural experiment. Further analysis reveals that the effects of local corruption on reporting conservatism are weaker when firms are less subject to expropriation by corrupt officials. In summary, our findings imply that firms adopt conservative accounting to systematically understate their earnings and asset values, thereby curbing the expropriation of firm resources by corrupt officials.

Keywords: Political Corruption, Anti-corruption Campaign, Conditional Accounting Conservatism, Financial Reporting, Earnings Shielding

JEL Classification: D22, D72, D73, M41