Conservatism, Disclosure and the Cost of Equity Capital

34 Pages Posted: 8 Sep 2010 Last revised: 20 Feb 2013

See all articles by Tracy Martin

Tracy Martin

University of Queensland - Business School

Peter Clarkson

University of Queensland - Business School; Simon Fraser University (SFU) - Beedie School of Business; Financial Research Network (FIRN)

Date Written: December 5, 2012

Abstract

This study seeks insights into the economic consequences of accounting conservatism by examining the relation between conservatism and cost of equity capital. Appealing to the analytical and empirical literatures, we posit an inverse relation. Importantly, we also posit that the strength of the relation is conditional on the firm’s information environment, being the strongest for firms with high information asymmetry and the weakest (potentially negligible) for firms with low information asymmetry.

Based on a sample of U.S. listed entities, we find, as predicted, an inverse relation between conservatism and the cost of equity capital, but further that this relation is diminished for firms with low information asymmetry environments. This evidence indicates that there are economic benefits associated with the adoption of conservative reporting practices and leads us to conclude that conservatism has a positive role in accounting principles and practices despite its increasing rejection by accounting standard setters.

Keywords: conservatism, disclosure, cost of equity capital, signaling, information risk

JEL Classification: M41

Suggested Citation

Martin, Tracy and Clarkson, Peter, Conservatism, Disclosure and the Cost of Equity Capital (December 5, 2012). Australian Journal of Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1673516 or http://dx.doi.org/10.2139/ssrn.1673516

Tracy Martin

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Peter Clarkson (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Simon Fraser University (SFU) - Beedie School of Business ( email )

8888 University Drive
Burnaby, British Colombia V5A 1S6
Canada

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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