Social Capital and Accounting Conservatism

Abstract

In this paper, we investigate the relationship between social capital and accounting conservatism. We measure social capital by the strength of civic norms and the density of social networks in a community and define accounting conservatism as earnings that reflect bad news more quickly than good news. We argue that firms headquartered in regions with stronger social capital have greater reputational concerns, face more social monitoring from stakeholders, and have better access to information and resources. These societal attributes discourage managers from delaying the recognition of bad news, resulting in higher accounting conservatism. Consistent with these arguments, we find that U.S. publicly listed firms located in counties with higher social capital display greater accounting conservatism. We also find that firms in high social capital regions prefer hiring managers with proven records of conservative accounting and that social capital reduces the asymmetric market reaction to bad versus good news disclosure. Our results are robust to using alternative measures of accounting conservatism and tests addressing endogeneity. Finally, using structural equation modeling (SEM), we show that accounting conservatism acts as a potential mechanism through which social capital reduces firms’ idiosyncratic risk.

Keywords: Social capital, accounting conservatism, firm risk

JEL Classification: M41, G32, Z13