The Effect of Conditional Conservatism on Cost of Equity Capital

This study investigates the relationship between conditional conservatism and the cost of equity capital. The conditional conservatism rate is measured, using Callen et al (2009) at firm-year level; and the impact of conditional conservatism on cost of equity capital at firm and portfolio level is studied, using the three Fama and French (1993) factor model. The data used consists of a sample of 82 firms that are publicly traded in the Tehran Stock Exchange (TSE) in the period 2001-2009. A multi-variable regression model is used for testing of hypotheses in a cross-sectional and time series framework. The results from hypotheses testing show that there is a significant negative relationship between conditional conservatism and cost of equity capital, and that the higher the degree of conditional conservatism the lower is the firm’s cost of equity capital. The results also show that there is a positive relationship between conditional conservatism and portfolio’s cost of capital. This relationship is statistically significant for both the firms with medium and high conservatism portfolios, but not for the firms with low conservatism portfolio.