The Effect of Accounting Conservatism on Credit Ratings and Cost of Debts29) －Empirical Evidence for Listed Firms and Non－listed Firms－
Asian Tax Journal Vol. 18 No. 6 (2017), pp. 9-51
Abstract
This study examines how accounting conservatism influences a firm’s credit rating and cost of debt. Accounting conservatism is traditionally defined as asymmetric timely recognition between loss and gain (Basu 1997), and the extreme form of conservatism in accounting is expressed by the adage “anticipate no profit, but anticipate all losses (Watts 2003a, 2003b)”. However, Watts (2003a, 2003b) provides alternative explanation on the accounting conservatism：it plays an important role to protect investors and creditors by enhancing the efficiency of contracts while mitigating the decline in firm value. Since accounting conservatism is known as an indicator significantly affecting the usefulness of accounting information and the earnings quality, it has been an important research topic in academia as well as in practice. Prior literature documents that conservative accounting can increase the transparency in financial reporting of a firm (e.g., Ball et al. 2000；Choi and Yoon 2006 etc.). Some studies reveal that firms using more conservative accounting methods tend to have higher credit ratings as well as lower cost of debt (Ahmed et al. 2002；Zhang 2008) while others suggest that accounting conservatism measured by timely loss recognition differs between public firms and private firms (Ball and Shivakumar 2005) and that higher audit quality is associated with conservatism in accounting (Hwang et al. 2008). This paper differs from the discussed studies by providing comprehensive analysis on the relations between accounting conservatism and firms’ credit ratings or their cost of debt as well as the difference in these relations on audit quality between the listed firms and the non－listed firms. To investigate the research questions of this study, we collect the sample including credit rating data from KISVALUE database provided by NICE Information Service. As a proxy for cost of debt, we use both the average interest rates and average spread of interest rates from borrowings (Jiang 2008；Park and Yoon 2013) as well as ranked variables for these two proxies (Park and Kim 2013). On the other hand, we adopt the unconditional conservatism model in Paek and Lee (2004), an extension on the model by Penman and Zhang (2002), to estimate accounting conservatism. The final sample is 52,320 firm－year observations from non－financial industry for 8 years between 2007 and 2014, which consists of 7,936 observations of the listed firms and 52,320 observations of the non－listed firms. The results are as follows. First, after controlling variables which are known to affect credit rating, firms using more conservative accounting seem to have higher credit ratings whether the firm is public or private, implying that the credit rating agencies, which are professional in financial analysis of firms, are more likely to assign good rates on more conservative firms in financial reporting regardless of the listing status. Second, This paper do not find a negative relation between accounting conservatism and cost of debt when using the full sample and nonlisted firms. However, more conservative in accounting is associated with lower cost of debt when using listed firms only. These results indicate that the creditors consider increases in accounting conservatism of listed firms as a positive signal and impose lower interest rate for them. On the other hand, non－listed firms are likely to be less conservative in accounting (Ball and Shivakumar 2005) with lower quality of earnings (Choi and Kwak 2010) compared to listed firms. Thus, creditors are less likely to reflect the increases in accounting conservatism in determining the interest rate. Third, audit quality does not appear to affect the relations between accounting conservatism and firms’ credit ratings. However, this result does not hold when the full sample is split into listed firms and non－listed firms. A positive relation between the accounting conservatism and firms’ credit ratings seem to be more significant for listed firms audited by Big 4 audit firms. Finally, audit quality seems to strengthen a negative relation between the accounting conservatism and cost of debt, but the difference is mainly driven by listed firms rather than non－listed firms. To summarize, the results of this paper suggest that the credit rating agencies and creditors appreciate accounting conservatism in listed firms, especially those audited by Big 4 auditor, compared to that in non－listed firms. These findings can shed a further light on how the credit rating agencies and creditors evaluate the conservatism in accounting based on the listing status or audit quality.
Keywords
- Accounting conservatism
- Firms’ credit ratings
- Cost of debt
- Listed status
- Audit quality
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