The effect of conservatism on cost of capital: MENA evidence

Abstract

The purpose of this article is to investigate the economic consequences of accounting conservatism in the Middle Eastern and North African (MENA) region. In particular, motivated by the lack of such studies in the context of emerging countries, we empirically examine the effect of conditional conservatism on firms' cost of equity capital. Using a sample of firms pertaining to 13 MENA countries during the period 2004-2007, we conduct three sets of tests. First, we assess the existence of conservatism in our sample following the model of Basu (1997). Second, we examine the association between conservatism and cost of equity capital. Third, we test the effect of two disaggregated measures of conservatismconservatism with respect to bad news (BNEWS) and conservatism with respect to good news (GNEWS) on the cost of equity.Results suggest that, overall firms in MENA region adopt conservative reporting. Furthermore, as predicted we find a negative association between conditional conservatism and the cost of equity capital. This evidence is robust to time series changes of variables and cross-country differences. The results also report a negative association between the two disaggregated measures of conservatism and the cost of equity capital. Our article gives additional light on the benefits of accounting conservatism.

The Impact of Accounting Conservatism and Voluntary Disclosure on the Cost of Capital of Industrial Companies in Jordan

“…They further found that conservatism regularly declines the improvement of the firm's information environment. It is also supported by the results of (Khalifa & Ben Othman, 2015;Zare et al,. 2013;Lara et al, 2011;Gietzmann & Trombetta, 2003).…”

“…The results of the full sample model revealed that accounting conservatism and voluntary disclosure have significant negative impacts on the firms' cost of capital. (Khalifa & Ben Othman, 2015) examined the economic results of accounting conservatism in emerging economies, particularly in the region of the Middle East and North Africa by using three models include well-known Basu's (1997) model to assess the presence of conservatism, the effect of conservatively reporting bad news and good news on the cost of equity capital, and disaggregated their measurements of conditional conservatism into conservatism with respect to bad news and conservatism with respect to good news. Their results revealed that both have the same negative impact on the cost of equity capital, which implies that conservatism provides the same amount of information irrespective of the type of news.…”

The effect of ex ante and ex post conservatism on the cost of equity capital: A quantile regression approach for MENA countries

“…However, evidence of such effects, as reported in these studies, is mixed and inconclusive. For example, Francis et al (2004) report no significant association, Chan et al (2009) and Biddle et al (2012) show a positive association, however, Artiach and Clarkson (2014) Garcia et al (2011), Khalifa and Ben Othman (2015) and Li (2014) find a negative effect of accounting conservatism on the cost of equity capital. The apparent inconsistency of the findings may be ascribed to the regression approach employed to test such association (Rush et al (2014)).…”

“…Foreign investors will therefore be concerned withthe rate of return (Firm's COEC) that receives in exchange for their investments. Moreover, firms in MENA countries are recognized as applying accounting conservatism practices (Khalifa and Ben Othman, (2015) and Khalifa et al, (2016)). Therefore, MENA emerging countries is an interesting context for examining the association between accounting conservatism and the cost of equity.…”

An Empirical Analysis On How Conservatism Influences Cost Of Equity Capital: Evidence From Turkey

“…The findings of the study demonstrate that cost of capital decreases as the degree of conservatism in the firm increases. Another concurrent study conducted by Khalifa and Othman (2015) utilizes the firm-specific measure of conditional conservatism developed by Khan and Watts (2009) The relationship has also been evaluated with an emphasis on debt capital by the early work of Ahmed et al (2002). They discuss that conservative accounting policies tighten dividend policy, which results in a reduction in the amount of return required by bondholders as the risk of excessive dividend payments is mitigated.…”