Employee Firing Costs and Accounting Conservatism: Evidence From Wrongful Discharge Laws

Abstract

This paper identifies the causal effect of a firm’s employee firing costs on its accounting conservatism, using the staggered adoption of U.S. state wrongful discharge laws that increase a firm’s cost of firing employees. We find a significant increase in accounting conservatism for firms headquartered in states that pass such laws relative to firms headquartered elsewhere. This effect is stronger for firms that are more labor-intensive, for firms that have higher propensity to fire employees, for firms that make more firm-specific investment, and for firms that face greater operation uncertainty. Overall, our findings indicate that higher firing costs result in more conservative accounting decisions by firms.