Federal Government Contracts and Financial Reporting Quality

Abstract

Government spending is essential for the US economy, and the amount of capital that flows from the government to US firms increased substantially in recent years. Despite the economic importance of the corporate-government contracting relationship, we know little about the firm-level financial outcomes associated with government contracts. Federal government regulations require federal contractors to maintain strong internal control over financial reporting and government contractors have strong incentives to maintain government contracts. As a result, we expect and find that corporate government contracting relationships are associated with higher firm-level financial reporting quality compared to non-government contractors. Further, we find that the improvement of financial reporting quality begins when a firm becomes a federal contractor and greater amounts of government contracts revenue are associated with higher levels of financial reporting quality. We also find the quality of financial reporting weakens after a firm loses government contracts. Collectively, our empirical results suggest that having the government as a customer has a positive impact on the quality of financial reports.