Conservatism, Disclosure and the Cost of Equity Capital
University of Queensland - Business School
University of Queensland - Business School; Simon Fraser University (SFU) - Beedie School of Business; Financial Research Network (FIRN)
December 5, 2012
Australian Journal of Management, Forthcoming
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.
Number of Pages in PDF File: 34
Keywords: conservatism, disclosure, cost of equity capital, signaling, information risk
JEL Classification: M41Accepted Paper Series
Date posted: September 8, 2010 ; Last revised: February 20, 2013
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