The influence of uncertainty on financial reporting behavior: The case of P&C insurers

Abstract

We examine how uncertainty about a firm's future cash flows influences the quality of its accounting information. As uncertainty increases, information asymmetry between managers and stakeholders will almost certainly increase, amplifying the potential influence of uncertainty. We focus on a specific setting where severe levels of uncertainty can influence financial reporting, the property-casualty (P&C) insurance industry and use catastrophes as a shock to the level of uncertainty regarding P&C insurer's future cash flows. We use P&C firms’ claim loss estimation errors as a proxy for accounting information quality. Results suggest that, in times of heightened uncertainty, managers respond by increasing accounting information quality. Moreover, managerial claim loss forecasts are more accurate for publicly traded P&C firms relative to privately—or mutually—owned P&C firms as catastrophe exposure increases. Additionally, claim loss estimates are incrementally more accurate in times of heightened uncertainty for public P&C firms with higher institutional ownership or analyst following. These results corroborate the conjecture that managers’ decisions to provide more accurate forecasts in times of heightened uncertainty are attributable to an increased demand for better information by external stakeholders.