The Interactive Effect of lawsuits and Investor Sentiment on Accounting Conservatism

Inappropriate response of executives to investor sentiment can lead to litigation and misallocation of funds, for this reason, companies set up conservative accounting in response to investor sentiment. This paper investigates the association between investor sentiment and accounting conservatism. For this purpose, the data of 119 companies listed in Tehran Stock Exchange for the period of 2008 to 2017 were extracted and combined data regression model was used to test the research hypotheses. The results show that managers identify economic losses in a timely manner during periods with high investor sentiment. In addition, the relationship between sentiment and conservatism is stronger for companies whose values tend to be high. We also find that the relationship between sentiment and conservatism is higher for companies with higher litigation risk. Overall, our results suggest that companies report earnings more conservatively in response to higher investor sentiment in order to mitigate potential litigation costs. These findings have implications for regulators and standard setters who have deemphasized accounting conservatism in recent years.