The Effect of Conditional Conservatism on Cost of Equity Capital

Abstract

This study investigates the relationship between conditional conservatism and the cost of equity capital. In this study conditional conservatism rate is measured based on Callen et al (2009) at firm-year level and the three Fama and French (1993) factor model is used to investigate the impact of conditional conservatism on the cost of equity capital at firm and portfolio level. The sample consists of 82 firms that are publicly traded in the Tehran Stock Exchange (TSE) over the period 2001-2009. A multi variable regression model has been used for testing of hypotheses in cross sectional and time series forms. Obtained results show that there is a negative relationship between conditional conservatism and the cost of equity capital and higher degree of conditional conservatism decreases firm’s cost of equity capital. Also, there is a positive relationship between conditional conservatism and portfolio’s cost of capital. This relationship is statistically significant in the case of middle conservatism portfolio and high conservatism portfolio. However, this is insignificant in case of low conservatism portfolio.

Keywords

• conditional conservatism
• cost of equity capital
• asymmetric timeliness
• three fama and french factor model