Employee firing costs and accounting conservatism: Evidence from wrongful discharge laws

Abstract

AbstractThis paper identifies the causal effect of a firm's employee firing costs on its conditional conservatism, using the staggered adoption of US state wrongful discharge laws (WDLs) that increase a firm's cost of firing employees. We find that the adoption of WDLs leads to a significant increase in conditional conservatism. This result is greater for firms that are more labor‐intensive, have higher propensities to fire employees, make more firm‐specific investments and have greater risk. Overall, our findings support the view that higher firing costs lead to greater demand for conditional conservatism to decrease investment inefficiencies because higher firing costs make inefficient investments (including overinvestment in negative‐net present value (NPV) projects and delays in disinvesting poorly performing projects) costlier for the firm.