The role of accounting conservatism in firms' financial decisions

Publication Type

Conference Paper

Publication Date

1-2012

Abstract

This paper investigates whether financial reporting conservatism is related to firms’ financial flexibility and their access to capital. If conservatism facilitates monitoring and governance by capital providers, they should be more willing to extend financing and increase firms’ access to capital. However, because conservatism leads to systematic understatement of net worth and weakens the appearance of firms’ balance sheet strength, it could also reduce firms’ access to capital. This study tests these two opposing views of the relationship between conservatism and firms’ financial flexibility. Results indicate that firms with greater reporting conservatism exhibit less flexibility in their corporate liquidity management, in their debt or equity issuance decisions, in the sensitivity of their investments to financing constraints and in their payout policies. Overall, results suggest that although firms enjoy lower debt contracting costs by reporting conservatively, they forgo some flexibility in future access to capital, and this affects their financial decisions.

Keywords

Accounting Conservatism, Access to Capital, Financial Constraint

Discipline

Accounting | Corporate Finance

Research Areas

Financial Performance Analysis

Publication

American Accounting Association Financial Accounting and Reporting Section Midyear Meeting

City or Country

Chicago, IL, USA

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