The effect of conservatism on cost of capital: MENA evidence

Abstract

The purpose of this article is to investigate the economic consequences of accounting conservatism in the Middle Eastern and North African (MENA) region. In particular, motivated by the lack of such studies in the context of emerging countries, we empirically examine the effect of conditional conservatism on firms’ cost of equity capital. Using a sample of firms pertaining to 13 MENA countries during the period 2004–2007, we conduct three sets of tests. First, we assess the existence of conservatism in our sample following the model of Basu (1997). Second, we examine the association between conservatism and cost of equity capital. Third, we test the effect of two disaggregated measures of conservatism – conservatism with respect to bad news (BNEWS) and conservatism with respect to good news (GNEWS) on the cost of equity. Results suggest that, overall firms in MENA region adopt conservative reporting. Furthermore, as predicted we find a negative association between conditional conservatism and the cost of equity capital. This evidence is robust to time series changes of variables and cross-country differences. The results also report a negative association between the two disaggregated measures of conservatism and the cost of equity capital. Our article gives additional light on the benefits of accounting conservatism.