Corporate Political Connectedness and Accounting Quality: A Quasi-Natural Experiment Albert Kwame Mensah College of Business City University of Hong Kong 83 Tat Chee Avenue Kowloon Tong Hong Kong SAR
[email protected] (+852) 3442-2255 /53162520 First draft: October 2018 This draft: January 2019 ABSTRACT: A number of townships, cities, counties, and states across the U.S. have recently passed measures, resolutions, ordinances, and laws modeled on the American Anti-Corruption Act, which aims to: (1) “make it illegal to purchase political influence,” and (2) “end secret money.” I exploit these staggered events—occurring between 2014 (the first year of adoption) and 2017—as exogenous negative shocks to both legal and illegal affiliations with politicians, and provide new causal evidence on the effect of political connection on financial reporting, as a key corporate decision area. Using a difference-in-differences estimation for the 2010-2018 quarterly reporting period, I find that, relative to firms in non-adopting locations, firms headquartered in adopting locations have significantly higher accounting quality (as proxied by several non-directional measures of accruals). I then focus on target beating (as a specific type of managerial incentive), where I find that, relative to control firms, treated firms are also less likely to: (1) use income-increasing accruals to meet/beat analyst earnings forecasts, and (2) meet/beat analyst earnings targets by up to one cent. Finally, I show that the stock market responds favorably to this ex-post enhancement in the quality of earnings, which also culminates in stock prices better capturing information about future earnings and cash flows.