STAKEHOLDER ORIENTATION AND ACCOUNTING CONSERVATISM : EVIDENCE FROM A NATURAL EXPERIMENT

We examine the effect of the staggered adoption of state-level constituency statutes on stakeholder demand for accounting conservatism. The adoption of state-level constituency statutes allows directors to consider stakeholder interests when making business decisions, thereby exogenously increasing a firm’s stakeholder orientation. Using a difference-indifferences analysis, we find that the increase in stakeholder orientation due to the adoption of the constituency statutes leads to a significant decrease in accounting conservatism. In other words, as firms pay more attention to stakeholder interests, accounting conservatism decreases. Our cross-sectional analyses show a more pronounced decrease in accounting conservatism for firms with ex ante higher stakeholder demand for conservatism as proxied by higher transient institutional investor ownership and lower liquidation values and for firms with more powerful stakeholders who have the ability to influence a firm’s financial reporting policy ex ante. Our findings suggest that 1) stakeholders demand for accounting conservatism as a mechanism to protect their interests and 2) stakeholder orientation substitutes for accounting conservatism in protecting stakeholder interests.