Director-Liability-Reduction Laws and Conditional Conservatism

Abstract

We study non-officer directors’ influence on the accounting conservatism of U.S. public firms. Between 1986 and 2002, all 50 U.S. states enacted laws that limited non-officer directors’ litigation risk without changing officer directors’ litigation risk. We find that conditional conservatism decreased after the staggered enactments of the laws, which we attribute to less non-officer-director monitoring of financial reporting in affected firms. Conservatism fell less when shareholder or debtholder power was high, consistent with major stakeholders moderating the influence of non-officer directors. We verify that our results stem from reductions in the asymmetric timeliness of accruals and, specifically, its current assets components. We also show that affected firms switched away from Big N auditors more often, which reduced these firms’ commitment to conservative financial reports.