Investor Sentiment and Conditional Accounting Conservatism

Abstract

Prior research presents mixed results on how managers alter their voluntary disclosures in response to investor sentiment, with evidence indicating that managers both attempt to correct and attempt to exacerbate optimistic market expectations during these critical periods. We examine a mandatory disclosure (GAAP earnings) and predict that career and litigation concerns should be sufficient to encourage the reporting of bad news more timely fashion when investor sentiment is high. We find that GAAP earnings are more (less) conservative in periods of high (low) investor sentiment, especially for companies where incentives encourage conservative reporting. Specifically, the sentiment-conservatism relationship is stronger for firms with greater sentiment-price sensitivity, higher litigation risk, Big Four auditors and stronger corporate governance.