Labor skill and accounting conservatism

We examine the role of labor market frictions in shaping firms’ accounting policies. We find that firms’ reliance on high-skill labor is negatively related to accounting conservatism, presumably because higher labor adjustment costs make conservative accounting policies more costly. Cross-sectional tests further support the notion that labor adjustment costs are the main driver for the negative relation between labor skill and accounting conservatism. Specifically, the negative relation is more pronounced when a firm i) operates in more competitive industries, ii) has a higher voluntary employee turnover rate, and iii) is more financially constrained. Finally, we show that the positive implication of accounting conservatism for future operating performance and cost of debt is weaker for firms requiring high labor skill, providing plausible explanations for a negative relation between labor skill and accounting conservatism. Collectively, we provide novel evidence on the relation between labor force heterogeneity and accounting conservatism.