Political Connections and Accounting Conservatism

Firms supply accounting conservatism in response to debt/equity contracting, litigation, political costs, and taxation demand from stakeholders. I examine whether political connections between U.S. firms and politicians moderate and/or intensify the impact of these demands on the supply of conditional and unconditional conservatism. I measure political connections based on the association between firms' campaign contributions and equity ownership in firms by U.S. House and Senate representatives. I measure conditional conservatism using an earnings-return model and unconditional conservatism using a persistent negative accruals proxy. I find that political connections moderate the effect of the debt contracting (litigation) demand for conditional (unconditional) conservatism. My results demonstrate whether and how political connections of U.S. firms can affect the four demands for and the supply of the two forms of conservatism. The collective evidence suggests that political connections serve as an alternative channel to reduce stakeholders' debt contracting and litigation demand for accounting conservatism.