Conditional conservatism and cost of capital |
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Authors: | Juan Manuel García Lara Beatriz García Osma Fernando Penalva |
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Affiliation: | 1.Department of Business Administration,Universidad Carlos III de Madrid,Getafe,Spain;2.Department of Accounting,Universidad Autónoma de Madrid,Madrid,Spain;3.IESE Business School,University of Navarra,Barcelona,Spain |
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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. |
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