b'investors about it so they know this has happened and it willcreated strict new rules for accountants and auditors and have accounting implications for us in the future.imposed more stringent recordkeeping requirements with What Czerney and his colleagues found is that these Typethe goal of promoting the accuracy of financial reporting for II subsequent events actually do affect the current finan- publicly held companies. Because of these new litigation and cial statementsthey lower the quality of the financialreputational concerns, auditors have incentive to be more reporting. Company managers have relatively fixed timeconservative in their assessment of their clients financial and resources to devote to preparing financial statements,statements. and they might also be attending to the legal matter, helpingAuditor conservatism has benefits: High-quality audit with cleanup from a natural disaster, or involved in issuingreports can make it easier for clients to access financing more stock or debt. In essence, theyre kind of distractedand reduce agency costs. But Mahfuz Chy, an assistant and their time is stretched thin or distracted away from theirprofessor of accountancy in the Trulaske College of Busi-primary responsibility of financial reporting, Czerney says.ness, and his colleague found that there are also costs to The same is true of the auditor: If you also have a bigauditor conservatism. event that happens to one of your clients and your officeIf auditors are more strict, it does help to curb those doesnt have a lot of extra people or has a lot of other stuffexcesses in accountingthe accounting numbers become going on at the same time, like a number of other auditsmore conservative and managers cannot exercise their happening concurrently, its going to be more difficult forincome-increasing accounting discretion, Chy says. But you to respond to that subsequent event in an appropriateif youre forcing managers in one way not to exercise their way.discretion, they are going to try to offset the stringency in When managers and auditors are resource-constrained,another way, which could be even worse. the quality of their reporting suffers, and the informationThe researchers found that when companies experience they give to investors is not as accurate. The researchersan increase in auditor conservatism, they reduce investments found that Type II subsequent events are associated within research and development by nearly 6%. By reducing higher odds of a subsequent restatement. And its not thetheir long-term investment in R&D, they increase their existence or nature of the events themselves that leads tocurrent period earnings and meet short-term performance lower post-audit financial reporting quality but rather thetargets. But that could be even more harmful because you timing of the events during the year-end closing process.really need innovation in the economy, Chy says. The firms Companies have some discretion about when thesethe researchers studied received approximately 7% fewer subsequent events happen, Czerney says. For example, ifpatents and 10% fewer citations, and the results were more their attorneys are working on settling a lawsuit and peoplepronounced when the firms faced greater equity and debt from management are involved, they have discretion as tomarket pressures and had greater litigation risk. when they actually work on it. If they have to file their finan- These findings have policy implications, Chy says: The cial statements at the end of February, why not hold off onprevailing notion is that auditor conservatism is always good. settlement negotiations until the beginning of March? OrBut were showing that there could be some harmful effects if they need more money so they can grow their companyif auditors are too conservative. When there is discussion and they want to issue debt or equity, thats a very time-con- about auditor conservatism in academia and policymaking, suming event. Does it need to be done during their finan- we need to think about all the aspects and hit a balanced cial reporting period? Or can it wait until March 15? Itsapproach so auditors are conservative but not so much so important for managers to have some awareness that thesethat they are impeding innovation. events do have consequences and can affect the quality of theThe study, Real Effects of Auditor Conservatism, information that theyre making available to investors.has been accepted for publication in Review of Accounting The study, Do Type II Subsequent Events ImpairStudies.Financial Reporting Quality? was published in TheDeficits Matter Accounting Review. Felipe Bastos Gurgel Silva was in a predicament. The Impeding Innovationassistant professor of accountancy in the Trulaske College The fall of Enron has had significant implications for theof Business wanted to know what effect a governments accounting profession. The quality of financial statementfiscal deficit might have on banks credit risk and loan-loss audits was called into question, and the media and regulatorsprovisions. But unlike a scientist in a lab who measures the held audit firms responsible. In 2002, President Georgeeffect of a given treatment in a randomized experiment with W. Bush signed into law the Sarbanes-Oxley Act, whicha treatment group and a control group, Silva couldnt assign 18 School of Accountancy'