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http://ssrn.com/abstract=1544307
 
 

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Conditional Conservatism and Cost of Capital


Juan Manuel García Lara


Universidad Carlos III de Madrid - Department of Business Administration

Beatriz Garcia Osma


Universidad Autonoma de Madrid

Fernando Penalva


IESE Business School - University of Navarra

March 23, 2010

Forthcoming in Review of Accounting Studies, Vol. 16, No. 2, June 2011

Abstract:     
We empirically test the association between conditional conservatism and cost of equity capital. Conditional conservatism imposes stronger verification requirements for the recognition of economic gains than economic losses, resulting in earnings that reflect losses faster than gains. This asymmetric reporting of gains and losses is predicted to lower firm cost of equity capital by increasing bad news reporting precision, thereby reducing information uncertainty (Guay and Verrecchia 2007) and the volatility of future stock prices (Suijs 2008). Using standard asset-pricing tests, we find a significant negative relation between conditional conservatism and excess average stock returns over the period 1975-2003. This evidence is corroborated by further tests on the association between conditional conservatism and measures of implied cost of capital derived from analysts’ forecasts.

Number of Pages in PDF File: 42

Keywords: Conditional conservatism, asymmetric reporting, cost of capital, information precision, uncertainty

JEL Classification: G10, G38, M41

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Date posted: January 29, 2010 ; Last revised: March 24, 2010

Suggested Citation

García Lara, Juan Manuel and Garcia Osma, Beatriz and Penalva, Fernando, Conditional Conservatism and Cost of Capital (March 23, 2010). Forthcoming in Review of Accounting Studies, Vol. 16, No. 2, June 2011. Available at SSRN: http://ssrn.com/abstract=1544307

Contact Information

Juan Manuel García Lara (Contact Author)
Universidad Carlos III de Madrid - Department of Business Administration ( email )
Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain
Beatriz Garcia Osma
Universidad Autonoma de Madrid ( email )
Departamento de Contabilidad
Avda. Fco. Tomas y Valiente 5
Madrid, Madrid 28049
Spain
Fernando Penalva
IESE Business School - University of Navarra ( email )
Avenida Pearson 21
Barcelona, 08034
Spain
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