Accounting Conservatism and the Cost of Capital: An International Analysis
Journal of Business Finance & Accounting, Forthcoming
43 Pages Posted: 13 Sep 2008 Last revised: 26 Jun 2015
Date Written: May 1, 2015
This paper examines the role of conditional accounting conservatism in mitigating the cost of equity and debt capital in an international setting. I find that firms domiciled in countries with more conservative financial reporting systems have lower cost of equity and debt capital. I further explore the cross-sectional variation of the above relations. I find that the negative association between conditional conservatism and the cost of equity and debt capital is more pronounced in countries with stronger legal enforcement, suggesting a complementary role between conservatism and legal institutions in capital markets. I also find that conservatism only reduces the cost of debt in countries where accounting-based covenants are widely used, consistent with the argument that conditional conservatism improves the efficiency of debt contracts via accelerating covenant violations.
Keywords: Cost of debt, Cost of equity, Conditional conservatism, Legal enforcement
JEL Classification: M41, M44, M47, G12, F00, G32, G38
Suggested Citation: Suggested Citation