Impact of firm-level uncertainty on earnings management and role of accounting conservatism

Abstract

This study investigates whether accounting conservatism can reduce earnings management in the wake of uncertainty. It is hypothesized that conservative reporting during uncertainty can reduce earnings management and increase firm value. Using 5354 firm-year observations from 2005-2018 through Khan and watts model, we provide evidence that accounting conservatism is a way to put limits on earnings management for firms facing uncertainty. We find a statistically significant impact of conservative reporting on firm value during an uncertainty. Uncertainty at the firm level is measured by applying “prospector” and “defender” business strategy. To measure earnings management Modified Jones model and Dechow and Dichev approach models applied. Our results provide insights into conservative accounting and have critical and practical implications for investors, researchers and standard setters. After addressing endogeneity and applying GMM estimator, our results remain confirmed.