Do High-Quality Auditors Mitigate the Real Effects of Accounting Conservatism? Evidence from Europe

This study examines how accounting conservatism and external audit quality jointly affect firms’ investment efficiency, with a particular focus on under-investment and over-investment behavior. It also investigates whether audit quality moderates the influence of conservative financial reporting on investment decisions. The analysis uses a panel dataset of 397 European listed companies from the STOXX Europe 600 index over the 2014–2023 period, covering nine sectors and 17 countries. Investment efficiency is measured following Biddle et al. (2009), while accounting conservatism is captured using the Khan and Watts (2009) C-Score. Panel regressions with industry, country, and year fixed effects are employed to test the hypotheses. The results indicate that accounting conservatism is negatively associated with investment efficiency and significantly increases under-investment by discouraging managers from undertaking positive-NPV projects, while its effect on over-investment is not statistically significant. Audit quality moderates this relationship by mitigating the adverse impact of conservatism on under-investment and enhancing overall investment efficiency. The findings highlight the governance role of external auditors in improving the reliability of conservative accounting and promoting more efficient capital allocation. This study contributes to the literature by integrating conservatism and audit quality into a unified framework of investment efficiency and provides new evidence from a European context on how external assurance interacts with accounting prudence to shape corporate investment decisions.