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Cost of Equity and Accounting Conservatism
Juan Manuel García Lara, Universidad Carlos III De Madrid
Beatriz García Osma, Universidad Autónoma De Madrid and Lancaster University
Fernando Penalva, IESE Business School
ABSTRACT. High quality accounting information is expected to lower the cost of equity capital by reducing perceived risk, increasing liquidity and reducing transaction costs. Consistent with this argument, prior empirical evidence documents a negative relation between cost of equity and several measures of earnings quality. Although conservatism is typically regarded as a desirable property of accounting information, there is scarce and mixed evidence about its effects on the cost of equity. Using different proxies for the cost of equity, we find that conditional accounting conservatism exhibits a robust negative association with the ex ante cost of equity. Our results are robust to controls for known risk factors and innate firm determinants that drive conservative accounting choices. Our findings suggest that investors have a preference for conservative accounting numbers.
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