Does economic policy uncertainty affect conservatism?: evidence from Korea

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Purpose This paper aims to examine the effects of economic policy uncertainty (EPU) on accounting conservatism in Korean firms. An increase in EPU could widen information asymmetry between insiders and outsiders, to the detriment of a firm’s investment decisions, stock price and cost of capital. This paper hypothesizes that Korean firms are likely to decrease accounting conservatism during high EPU due to inefficient institutional structure and weak corporate governance, together with the vulnerability of the Korean economy to exogenous shocks. Design/methodology/approach This study measures a firm’s level of conservatism using three accrual-based models proposed by Ball and Shivakumar (2006): 1) the cash flow model (CF model), 2) the Dechow and Dichev model (DD model) and 3) the Jones model. As a robustness test, this paper uses C-score model as an alternative measure of accounting conservatism. The data set used in this study is a total of 23,109 firm-year observations during the sample period from 2000 to 2018. Findings The test results show that an increase in EPU adversely affects Korean firms’ accounting conservatism, and that this adverse impact is more pronounced in financially distressed and non-manufacturing firms. This study’s findings highlight the importance of institutional structure during a period of high EPU, which can create incentives for either improving or deteriorating reporting quality. Originality/value This study adds new evidence to extant literature on the effects of EPU on managers’ choice of accounting policies and demonstrates that managers in emerging markets may have different incentives to cope with country-specific EPU fluctuations.