We predict that firms with stronger corporate governance will exhibit a higher degree of accounting conservatism. Governance level is assessed using a com posite measure that incorporates several internal and external characteristics. Consistent with our prediction, strong governance firms show significantly higher levels of con ditional accounting conservatism. Our tests take into account the endogenous nature of corporate governance, and the results are robust to the use of several measures of conservatism (market based and nonmarket based). Our evidence is consistent with the direction of causality flowing from governance to conservatism, and not vice versa, indicating that governance and conservatism are not substitutes. Finally, we study the impact of earnings discretion on the sensitivity of earnings to bad news across gover nance structures. We find that, on average, strong governance firms appear to use discretionary accruals to inform investors about bad news in a timelier manner.

a b s t r a c tWe argue that conservatism improves investment efficiency. In particular, we predict that it resolves debt equity conflicts, facilitating a firm's access to debt financing and limiting underinvestment. This permits the financing of prudent investments that otherwise might not be pursued. Our empirical results confirm these predictions. We find that more conservative firms invest more and issue more debt in settings prone to underinvestment and that these effects are more pronounced in firms characterized by greater information asymmetries. We also find that conservatism is associated with reduced overinvestment, even for opaque investments such as research and development.

Forthcoming in Review of Accounting Studies* We are grateful to Alon Brav for providing access to the ex ante cost of equity capital estimates, and to Dan Segal for his assistance in computing the CR conservatism proxy. We also appreciate the comments and suggestions from Gauri Bhat, Peter Electronic copy available at: http://ssrn.com/abstract=1544307 Conditional Conservatism and Cost of Capital ABSTRACTWe 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.

We study the economic determinants of conditional conservatism. Consistent with prior literature, we find that contracting induces only conditional conservatism and litigation induces both conditional and unconditional conservatism. We extend prior evidence by Qiang (2007) by showing that taxation and regulation induce not only unconditional conservatism, but conditional conservatism as well. We show that in certain scenarios taxation and regulation create incentives to shift income from periods with high taxation pressure and high public scrutiny to periods with lower taxation pressure and lower public scrutiny. These income shifting strategies are implemented by recognising current economic losses that, given managerial incentives to report aggressively, would not have been recognised otherwise, or by delaying the recognition of current economic gains that would have been recognised had circumstances been different.

Using a sample of Spanish listed firms for the period 1997 2002 we find that firms where the CEO has a low influence over the functioning of the board of directors show a greater degree of accounting conservatism. We measure the influence of the CEO over the board of directors using two aggregate indexes combining six (eight) characteristics of the functioning of the board of directors and its monitoring committees: board size, proportion of non executive directors, proportion of independent directors, whether the chairman of the board is an executive director, the number of board meetings, and the existence of an audit committee, a nomination/remuneration committee and an executive committee. We define conservatism as the asymmetric recognition speed of good and bad news in earnings, and we measure it following Basu (Journal of Accounting and Economics, 24, pp. 3 37, 1997) and Ball and Shivakumar (Journal of Accounting and Economics, 39, pp. 83 128, 2005). Our results are robust to alternative specifications and specific controls for investment opportunities and for the endogenous nature of corporate governance and earnings quality. Overall, our evidence shows that firms with strong boards use conservative accounting numbers as a governance tool, even in an institutional setting with low litigation risk such as Spain.