Conservative Financial Reporting and Cost of Equity: Evidence from Korea

Abstract

Prior studies provided mixed evidence regarding the relation between earnings conservatism and cost of equity.  This paper investigated whether earnings conservatism affects the cost of equity capital in emerging Korean market. Further, we explored whether the relation between conservatism and the cost of equity is influenced by the two economic factors, the ownership concentration of the largest shareholder and information asymmetry. Our empirical results showed that earnings conservatism is negatively related to the cost of equity capital and also the relation is more pronounced for the firms with high ownership concentration of the largest shareholders and high information asymmetry proxied by stock return volatility. These results suggested that the positive aspects of conservative financial reporting in the capital market are more strengthened in the poor information environment and more concentrated ownership structure, which is consistent with demand side of conservatism.

Keywords: Accounting conservatism, cost of equity, information asymmetry, ownership concentration

DOI: 10.7176/EJBM/14-10-12

Publication date:May 31^st 2022