6. Conclusion
Prior literature in accounting posits that conservatism can mitigate investment inefficiency in capital markets. We extend this line of research by examining the effect of conservatism on investment efficiency in the labor market, an important area that has been overlooked. We find that conservatism mitigates investment inefficiency, both over-investment and under-investment, in labor. This negative association between conservatism and investment inefficiency in labor holds in all possible scenarios of inefficient investment, including over-hiring, under-firing, under-hiring, and over-firing in the labor market, and it also holds after controlling for managerial ability, corporate governance, and other investments. Moreover, the results are both statistically and economically significant. Overall, our results contribute to a growing body of evidence suggesting that conservative financial reporting improves firms’ investment decisions in general, and in particular, labor investment decisions.
Our study has several limitations. First, while we find that conservatism is associated with improved labor investment efficiency, we note that our study is not designed to identify the underlying mechanism through which conservatism affects labor investment. Second, although we try to address the endogeneity in conservatism using SAB No. 101 as an exogenous shock to increase accounting conservatism, the association between conservatism and labor investment decisions may be driven by some underlying firm characteristics that we do not adequately control for in our empirical specifications. Third, although we use various measures of conditional conservatism and alternative tests to triangulate our results, our inferences ultimately depend on how well the conservatism proxies capture the underlying construct of conservative reporting. Fourth, our results are specific to the United States and may not carry over to other countries with different labor markets.
