Local Visibility Shocks to War Profiteers: New Tests of the Political Cost Hypothesis

• In Event: Government and Law

Abstract

Defense firms comprising the U.S. military-industrial complex rely on public support for continued government defense spending. We exploit an exogenous source of state-year variation in the visibility of defense firms to investigate the relationship between firm visibility and financial reporting. Our main tests use soldier fatalities per capita, by state and year, as an as-if-random source of variation in public scrutiny of the war effort and defense firms. We find that a one standard deviation increase in local soldier fatalities increases defense firms’ income-decreasing discretionary accruals by 0.61% of total assets. The magnitude of this effect increases monotonically with defense firms’ vulnerability to political costs. We further show that local media coverage of soldier fatalities accentuates the relationship while it is attenuated for defense firms with more political and market power vis-à-vis the U.S. Department of Defense. Our inferences are robust to a wide variety of empirical specifications, firm fixed effects, real actions-based earnings management measures, alternate measures of accrual-based earnings management and multiple placebo tests.

Authors

• Matthew Boland, Saint Mary's University

• David Godsell, University of Illinois-Urbana-Champaign