Labor Skill and Accounting Conservatism

We examine the relation between a firm’s reliance on high-skill workers and its accounting conservatism. We find that reliance on high-skill workers is negatively related to accounting conservatism, presumably because firms with higher labor adjustment costs are more concerned about the cost of conditional conservatism. We use a quasi-experiment based on an exogenous shock to Houston’s local labor market due to worker migration from New Orleans after Hurricane Katrina to examine the direction of causality. Cross-sectional tests support the notion that labor adjustment costs are the main driver for the negative relation between labor skill and accounting conservatism. Specifically, the relation is more pronounced when the firm i) operates in more competitive industries, ii) has a higher voluntary turnover rate, and iii) is more financially constrained. Collectively, we provide novel evidence on the interaction between labor force heterogeneity and accounting conservatism