The role of accounting conservatism in corporate innovation

Abstract

We provide evidence to determine whether conservative financial reporting is associated with firm‐level investments in innovation in China. We find that firms adopting a more conservative reporting policy invest substantially more in innovative projects. We also find that conservative reporting practices improve the association between executives' pay‐for‐performance and a firm's innovation efforts. The association between conservatism and firm‐level innovation is concentrated in firms that are in the non‐high‐tech industries, that have higher financial leverage and more product market competition. Our paper adds to public policy by providing evidence of the beneficial influence of accounting conservatism on higher innovation investment.