Abstract:

We examine how companies voluntarily change their financial reporting conservatism in response to an exogenous decrease in analyst coverage. We hypothesize that more severe information asymmetry and weaker external monitoring associated with such a decrease in analyst coverage exacerbate agency conflicts between contracting parties, which in turn creates a greater demand for conservative accounting. Consistent with this prediction, we document a significant increase in accounting conservatism following an exogenous drop in analyst coverage. Furthermore, the effect is stronger when the dropped analyst is more informed and when the affected firm has a higher financial leverage ratio, less favorable credit ratings, and a higher proportion of cash-based CEO compensation. The overall evidence is consistent with the notion that accounting conservatism arises as part of the efficient technology employed by firms to address agency problems between contracting parties.

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