Does economic policy uncertainty matter for financial reporting quality? Evidence from the United States

Theodora Bermpei (), Antonios Nikolaos Kalyvas (), Lorenzo Neri () and Antonella Russo ()
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Theodora Bermpei: University of Essex
Antonios Nikolaos Kalyvas: University of Southampton
Lorenzo Neri: Birkbeck University of London
Antonella Russo: Greenwich Business School, University of Greenwich

Review of Quantitative Finance and Accounting, 2022, vol. 58, issue 2, No 12, 795-845

Abstract: Abstract We examine the effect of economic policy uncertainty (EPU) on the financial reporting quality of US firms over 1999–2015. We use accruals-based earnings management as a proxy for financial reporting quality and the index of Baker et al. (Quart J Econ 131:1539–1636, 2016) as an EPU measure to show that they exhibit a positive and significant association. We also find a causal effect by employing three political polarization instruments for EPU. In a cross-sectional analysis, we further show that the positive relationship between EPU and earnings management strengthens for firms operating in politically sensitive industries, for firms in more financial distress, and during recessionary periods. We also provide evidence that increased financial constraints facilitate the positive relationship between EPU and earnings management. These findings are robust to the use of alternative measures of economic policy uncertainty and when we employ real earnings management as a dependent variable. These results indicate that managers aim to provide outsiders with an improved financial position of the company when EPU is high. Our findings suggest that investors, analysts, creditors, and regulators should be wary of firms’ financial reporting quality in periods of high economic policy uncertainty.

Keywords: Earnings management; Economic policy uncertainty (EPU); Financial reporting quality; Political sensitivity; E44; G14; M41 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s11156-021-01010-2

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