Policy Uncertainty and Accounting Quality

Abstract

Using data from 19 countries over the 1990–2015 period, we examine how economic policy uncertainty (EPU) affects accounting quality. We find that accounting quality, measured based on Nikolaev’s (2018) model, increases during periods of high policy uncertainty. This relation is confirmed by the negative association between EPU and performance-adjusted discretionary accruals in a multivariate setting, and it extends to various alternative measures of earnings properties. We also find that the positive relation between EPU and accounting quality is more pronounced for government-dependent firms and firms with higher political risk. Additional analyses based on institutional investors’ trading behavior, media freedom, and press circulation suggest that market participants’ attention is a mechanism through which EPU affects accounting quality. Further, we find evidence that high accounting quality can mitigate the negative effects of EPU on corporate investment and valuation.

Keywords: economic policy uncertainty; accounting quality; earnings management; investor attention; monitoring; press freedom