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Conditional conservatism and cost of capital

Author

Listed:
  • Juan Manuel García Lara

    (Universidad Carlos III de Madrid)

  • Beatriz García Osma

    (Universidad Autónoma de Madrid)

  • Fernando Penalva

    (University of Navarra)

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.

Suggested Citation

  • Juan Manuel García Lara & Beatriz García Osma & Fernando Penalva, 2011. "Conditional conservatism and cost of capital," Review of Accounting Studies, Springer, vol. 16(2), pages 247-271, June.
    • Handle: RePEc:spr:reaccs:v:16:y:2011:i:2:d:10.1007_s11142-010-9133-4
    DOI: 10.1007/s11142-010-9133-4
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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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