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The Impact of Conservatism on the Cost of Debt: Conditional versus Unconditional Conservatism
Heidi Vander Bauwhede,
Vlerick Leuven Gent Management School & Katholieke Universiteit Leuven
ABSTRACT. This paper extends research on the role of conservatism in debt contracting by examining the impact of both conditional and unconditional conservatism on the cost of debt. Based on arguments in Ball and Shivakumar (2005) and Ball et al. (2006), I expect that creditors reward conditional conservatism but not unconditional conservatism. Using a large sample of listed companies over the period 1999-2003, and using credit ratings as a measure of the cost of debt, I find that firms in industries with more conditional (unconditional) conservatism have a significantly lower (higher) cost of debt than firms in industries with less conditional (unconditional) conservatism. Moreover, I document a significantly negative relation between conditional and unconditional conservatism. The results are important for standard-setters for they support the argument that mandated unconditional conservatism can reduce contracting-efficient conditional conservatism (Basu 2005, p. 314).
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