Accounting conservatism and the cost of capital: an international analysis

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.