Director-Liability-Reduction Laws and Conditional Conservatism

Abstract

We study non-officer directors’ causal influence on the conditional conservatism of firms’ financial statements. We treat director liability reduction laws enacted by the U.S. states in different years since 1986 as exogenous shocks to non-officer directors’ litigation risk. We find a decrease in conditional conservatism after the law enactments, which varies predictably with cross-sectional variation in the demand for conditional conservatism from institutional owners and lenders. The results are robust to alternative conservatism measures and controls for endogenous self-selection of states of incorporation. Our results are consistent with non-officer directors monitoring and influencing the financial reporting process and have implications for corporate governance and corporate law reforms.