Labor Unemployment Insurance and Accounting Conservatism

• In Event: Timeliness of Reporting Bad News and Misstatements

Abstract

We use state-level increases in unemployment insurance (UI) benefits as exogenous shocks to unemployment risk to examine its effect on accounting conservatism. Due to the concern about job security, employees want their firms to timely release negative news (i.e., more conservative reporting) to protect their own interest. An increase in UI benefits, which reduces the unemployment cost, is expected to result in less accounting conservatism. On the other hand, employees require a premium on compensation when facing high unemployment risk. Therefore, firms have incentives to manage employees’ perceptions of job security by postponing bad news (less conservative) so as to reduce labor cost. Thus an increase in UI benefits is expected to mitigate the manipulating incentive leading to more conservatism. Employing the difference-in-differences analysis, we find an increase in accounting conservatism after the UI benefits change, supporting the employees’ perception management argument. Subsample tests show that this effect is driven by labor-intensive firms as well as firms with higher risk. Overall, our paper suggests that labor market frictions have a significant impact on firm accounting reporting policies.

Authors

• Huishan Wan, University of Northern Iowa

• Yixin Liu, University of New Hampshire

• Yilei Zhang, University of North Carolina at Charlotte