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

Xi Li

London School of Economics

Date Written: May 1, 2015

Abstract

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

Li, Xi, Accounting Conservatism and the Cost of Capital: An International Analysis (May 1, 2015). Journal of Business Finance & Accounting, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1261971 or http://dx.doi.org/10.2139/ssrn.1261971

Xi Li (Contact Author)

London School of Economics ( email )

United Kingdom

HOME PAGE: http://www.lse.ac.uk/accounting/facultyAndStaff/profiles/Li.aspx

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