Is Financial Reporting Quality Affected by Economic Policy Uncertainty? Evidence from Conditional Conservatism around the World

Abstract

This paper explores the relationship between economic policy uncertainty and financial reporting quality. Quality is operationalized using Ball and Shivakumar’s (2005) accruals-based measure of incremental bad news’ sensitivity. We hypothesize that increased uncertainty raises the demand for conditional conservatism that, in turns, leads to a larger incremental bad news’ sensitivity. Using firm-level data from 22 countries over 1995 to 2019, we find robust evidence that supports a positive relationship between economic policy uncertainty and incremental bad news’ sensitivity. This relationship is shaped by the prevalence of bank debt usage, judicial independence, and debt enforcement efficiency that is a measure of creditor protection.

Keywords: Economic policy uncertainty, Report quality, Conservative accounting, Capital markets, International

JEL Classification: G21, M4