Accounting conservatism and the cost of capital: international analysis∗

This study examines the contracting benefits of accounting conservatism on international debt and equity markets. Results show that firms domiciled in countries with more conservative financial reporting systems have significantly lower cost of debt and equity capital, after controlling for differences in legal institutions and securities regulations. I use one-year-ahead interest rate to measure the expected cost of debt and use the discount rates extracted from several accounting-based valuation models to estimate the expected cost of equity. Accounting conservatism is proxied by countrylevel timely loss recognition estimated from modified Basu (1997) model. I conduct a battery of robustness analyses, including adopting different measures for the cost of capital and conservatism and using different sample compositions, and get similar results. Findings in this paper contribute to the literature by highlighting the role of accounting information in assisting a country’s legal system to determine the performance of its capital markets.