The Effect Of Accounting Conservatism On The Cost Of Debt

Accounting conservatism is a traditional convention or principle in accounting recognition and measurement, and it is also one of the most important characteristics of financial statements. However conservatism is frequently criticised by accounting standard setters, researchers as well as practitioners. The Concept Framework released by FASB and IASB in2010no longer had the requirements of conservatism as one of the qualitative characteristics of useful financial information. Thus, will our accounting standards still insist on conservatism in the convergence with international accounting standards? This thesis studies the economic role of accounting conservatism from the perspective of debt financing. It analyses the effect of conservatism on the cost of debt based on the contracting theory, and uses empirical models to test this effect, finally concludes with some useful findings.The thesis is arranged into six parts as follows.Section1introduces the background and purposes of this study, the analysis framework and the innovations of the study.Section2reviews the relevant literature, specifically including two aspects, the measurement of accounting conservatism at firm level and the relationship between conservatism and debt.Section3discusses the meaning and categories of accounting conservatism and its role in the Concept Framework, then analyses the effect of conditional and unconditional conservatism on the cost of debt using the contracting theory, and develops the hypotheses.Section4describes the research design, namely the empirical proxies for conditional, unconditional and financial report conservatism, the cost of debt and other determinants of debt cost; the empirical regression model; and data collection. Section5presents the empirical results and conducts some robustness checks to ensure the reliability of the primary results.Section6concludes the thesis by summarizing the findings and the limitations in this study and at last offers some suggestions for future study.This thesis takes all the non-financial listed companies in the Shanghai and Shenzhen A-share stock markets from2005to2010as the research sample, with C-score, BTM and accumulated non-operating accruals to measure conditional, unconditional and financial report conservatism respectively, to examine the effect of different conservatism on debt cost. The findings are that conditional conservatism can help reduce debt cost, while unconditional conservatism not. This conclusion verifies the positive role of conditional conservatism in mitigating the conflicts between creditors and stockholders or management, timely transferring the signal of default risk to creditors so as to protect their interests, and eventually reducing the debt cost of debtor companies. Generally speaking, financial report conservatism yet increases the debt cost of the entity.This thesis at least makes contributions in the following aspects. Firstly, it combs the meaning and categories of accounting conservatism, states the irreplaceable role of conservatism in the Concept Framework; meanwhile its analysis about the economic effect of conservatism under our institutional background provides theoretical support for insisting on conservatism in accounting practice. Secondly, the findings of this thesis are useful to standard setters, creditors and companies who want to obtain loans. The relevant decision making of those parties is able to get reference from the conclusion of the active role of conditional conservatism in enhancing the efficiency of debt contract.