Political Uncertainty and Accounting Conservatism: Evidence from the U.S. Presidential Election Cycle

Abstract

We hypothesize that political uncertainty leads to higher agency costs between managers and shareholders resulting in an increased demand for accounting conservatism. Exploiting the exogenous variation in political uncertainty induced by the U.S. gubernatorial election cycle, we find that the asymmetric timeliness of news recognition increases with political uncertainty. Our political uncertainty hypothesis operates through three economic channels, namely, political power of the incumbent, industrial exposure to politics, and the alignment of managerial and investor incentives. Accordingly, we find that the political uncertainty effect is more pronounced when the governor has control of legislature and when patronage is weaker, when a firm belongs to an industry that is more exposed to politics, when managers are better disciplined by governance mechanisms and when their reputations are more tied to the firm.