Conditional Conservatism and Debt Versus Equity Financing

46 Pages Posted: 10 Apr 2016 Last revised: 3 Mar 2021

See all articles by Beng Wee Goh

Beng Wee Goh

Singapore Management University - School of Accountancy

Chee Yeow Lim

Singapore Management University - School of Accountancy

Gerald J. Lobo

University of Houston - C.T. Bauer College of Business

Yen H. Tong

Nanyang Technological University (NTU) - Nanyang Business School

Date Written: June 1, 2015

Abstract

Extant research suggests that conditional conservatism reduces information asymmetry between a firm and its shareholders as well as its debtholders. However, there is little evidence on whether conditional conservatism reduces information asymmetry differentially for shareholders and debtholders. We use the setting of a firm’s choice between equity and debt when it seeks a significant amount of external financing to examine this research question. We find that when firms raise a significant amount of external financing, the use of equity (versus debt) increases with the level of conservatism. We also find that the reduction in cost of equity associated with conservatism is greater for equity issuers than for debt issuers, but find no such difference when we examine cost of debt. In addition, we find that the positive effect of conservatism on the choice of equity issuance (versus debt issuance) is accentuated when the information asymmetry between the firm and its shareholders is more severe. Overall, our results suggest that conservatism reduces information asymmetry more between firms and shareholders than between firms and debtholders.

Keywords: conditional conservatism, financing policy, cost of equity, cost of debt, information asymmetry

JEL Classification: G32, M41

Suggested Citation

Goh, Beng Wee and Lim, Chee Yeow and Lobo, Gerald J. and Tong, Yen H., Conditional Conservatism and Debt Versus Equity Financing (June 1, 2015). Contemporary Accounting Research, Volume 34, Issue 1, pp. 216-251, 2017, Singapore Management University School of Accountancy Research Paper No. 2016-51, Available at SSRN: https://ssrn.com/abstract=2760170

Beng Wee Goh

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

Chee Yeow Lim

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

Gerald J. Lobo (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States
713-743-4838 (Phone)
713-743-4828 (Fax)

HOME PAGE: http://www.bauer.uh.edu/acct/acctprofile.asp?search=Gerald%20Lobo

Yen H. Tong

Nanyang Technological University (NTU) - Nanyang Business School ( email )

Singapore 639798
Singapore
65-6790-5743 (Phone)

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