Accounting conservatism, capital structure, and global diversification

Abstract

Purpose – The purpose of this paper is to investigate the effect of accounting conservatism (as a proxy for financial reporting quality) on the degree of financial leverage. In addition, this paper examines the impact of global diversification (as a proxy for operational complexity) on the relationship between conservatism and financial leverage. Design/methodology/approach – A panel data regression analysis is conducted for the period 2000-2006. The authors utilized a two-way fixed-effects model to control for unobservable firm characteristics and time effects that may influence the firm’s decision to report conservatively. Findings – This paper provides empirical evidence that conservatism is positively associated with the degree of financial leverage, and the influence of conservatism on financial leverage is enhanced by the degree of global diversification. Originality/value – A major issue in corporate finance is the identification of variables that influence corporate capital structure choices. The evidence presented in this paper reveals that more conservative financial reporting is associated with a higher degree of financial leverage in the firm’s capital structure. This effect increases with the extent of global diversification, indicating that bondholders place a higher value on conservatism when there is more information asymmetry between stakeholders and managers caused by global diversification.