Firm-level political risk and income smoothing

Abstract

The political cost hypothesis of positive accounting theory predicts that managers make accounting choices to minimize potential wealth transfers in the political process. Using a firm-level measure of political risk based on managers’ discussion of political topics in conference calls, we find that political risk is positively associated with income smoothing, consistent with managers reducing earnings variability to reduce stakeholder attention. This relation is stronger for firms more dependent on government purchases and firms under more stringent tax-related scrutiny. On the other hand, the relation is attenuated when firms incur more political lobbying expenses. Lastly, we do not find that increased investor demand for high-quality accounting information during periods of high economic policy uncertainty is the mechanism underlying our evidence. Our paper contributes to a better understanding of the role of political factors in managers’ accounting choices.