A Study of the Relationship between Conservatism and Capital Cost of Listed Companies: Some Iranian Evidences

Transcription

1 Ausralian Journal of Basic and Applied Sciences, 6(): -8, ISSN A Sudy of he Relaionship beween Conservaism and Capial Cos of Lised Companies: Some Iranian Evidences Mahdi Salehi, Mahmood emafar, 3 Pyman Khazaee Assisan Professor of Accouning, Ferdowsi Universiy of Mashhad, Mashhad, Iran. Assisan Professor of Accouning Deparmen, Boroujerd Branch, Islamic Azad Universiy, Iran. 3 M.A holder in Accouning, Boroujerd Branch, Islamic Azad Universiy, Iran. Absrac: In his sudy he relaionship beween wo crieria of conservaism has been invesigaed including ime asymmery of profi and raio of he marked value o book value o cos of common sock. The resuls of he sudy indicae ha he impac of conservaism on he cos of common sock capial indicae ha research resuls confirm he exisence of inverse relaionship beween conservaism and invesmen cons of common sock and his relaionship is imporan saisically. The resuls of he sudy show ha impac of asymmeric imeliness profis on he cos of common sock is more han he proporion of marked value o he book value. Key words: asymmeric imeliness profi, raio on of marked value o book value, cos of common sock capial. INTRODUCTION Tehran Sock Exchange (TSE) is one of he main componens of marke forming capial ha is mainline is o arac and direc he wandering and dispersed savings and liquidiy in sociey oward opimal pahs such ha wih opical allocaion of scarce financial resources, major par of capial could be absorbed in he mos profi aciviies and projecs. This marke is a confluence place for supplier and demander of capial. On he one hand, companies and manufacuring unis assuming individual invesmen and limied resources ener his marke. As a demander of capial and an he oher hand here are capial suppliers or shareholders who are considering he degree of aking a risk expec a cerain rae of reurn of supplied capial and considering ha hese invesor can inves heir funds in similar projecs. The expeced rae of reurn of invesing in insiue is he opporuniy cos of funds supplied by hem. Company performance and producion unis should be owards maximizing wealh for shareholders. One way o maximizing shareholders wealh which could be done wih represening dividends and increasing in he price of sock marke is ha he cos of all inpus including capial cos could be minimized. On he opposie side financial saemens are he mos imporan financial repor which senior managers of company are responsible for preparing hem afer preparaion, exra users can uilize hem. Wide range of users including various pars such as invesors, financial analys, bankers, credi donors and each of here componens according o diversiy of heir needs demand specific informaion and i is impossible ha a financial saemen producers provide all of hese needs. Due o he imporance of invesors wih regard o he pluraliy and heir direc influence on decisions and policies of he company hrough owning capial, more aenion is given o he needs of invesors. And i is assumed ha meeing needs of invesors give resul o fulfill he oher needs of users. If i can be seen a meaningful relaionship beween conservaism and capial cos. Then i can be claimed ha conservaism can reduce capial cos and can increase shareholders wealh. Conservaism: The mos common definiions of conservaism used in he financial accouning lieraure resul from wo disinc forms of conservaism; condiional conservaism and uncondiional conservaism (Beaver and Ryan 5). Condiional conservaism refers o he manifesaion of conservaism as he asymmery in response of earnings o good and bad news measured by he mehod developed in Basu, (997) (see, for example, Francis, e al, 4). Tradiionally, conservaism in accouning means when in doub chooses he soluion ha will be leas likely o oversae asses and income (Kieso, Weygand, and Warfield, 6). Thus, conservaive behavior involves choosing lower (raher han higher) revenues, higher (raher han lower) expenses, and recognizing unrealized losses bu no unrealized gains (Beaver, 998). In imes of growh in invesmen, his leads o a downward bias in repored earnings and ne asses. If he effec of he downward bias in conservaively repored earnings is no clearly undersood by analyss, i may lead o overly opimisic analyss forecass. The predicive abiliy of analyss is furher hampered when a firm s growh in invesmen changes, leading o a change in he effec of Corresponding Auhor: Mahdi Salehi, Assisan Professor of Accouning, Ferdowsi Universiy of Mashhad, Mashhad, Iran. Mahdi_salehi54@yahoo.com

2 Aus. J. Basic & Appl. Sci., 6(): -8, conservaism on repored earnings (Penman and Zhang ). If analyss consisenly and sysemaically misesimae he effec of accouning conservaism, do managers bridge his informaion gap by providing volunary disclosures? The objecive of his paper is o examine he relaion beween accouning conservaism and volunary disclosure behavior of managers. The heoreical proposiions are consisen wih he resuls and suggesions in Ahmed, e al., () ha he repuaion effec from conservaive accouning appears o reap real economic benefi in he form of reducions in he cos of deb. Consisen wih hese argumens is he idea, hough more simplisic, ha high qualiy firms can choose o be more conservaive and esablish ha hey do no need o use aggressive accouning pracices o provide srong earnings and herefore reurns o invesors. I is plausible ha marke paricipans also perceive a firm ha has adoped conservaive accouning pracices as less risky han a firm ha adops aggressive accouning pracices. Risk is reduced where here is a greaer degree of verifiabiliy and reliabiliy in he accouning numbers as a resul of he early recogniion of losses and poenial liabiliies and he conservaive valuaion of asses. Conservaism and Cos of Capial of Common Sock: Two imporan reporing feaures on conservaive accouning are asymmeric imeliness in recogniion of accouning gains versus losses and sysemaic undersaemen of ne asses (Givoly Jayn and Naarajan, 7; Roychowdhury and Was, 7). These wo feaures resul from accouns predisposiion o require a higher degree of verificaion and cerainy for he esablishmen of asses as compared wih liabiliies. Conservaism, one of he mos prominen characerisics of financial accouning, has influenced accouning pracices for cenuries and is associaed wih he conracing role of accouning (Was, 3). I is regarded as an efficien way o address he moral hazard problem arising from he asymmeric informaion among ineresed sakeholders. LaFond and Was, (8) conclude ha informaion asymmery beween inside and ouside equiy invesors generaes he demand for conservaism in financial saemens. Acually, his perspecive consiues our major hypohesis ha he sakeholders of firms wih less solid corporae governance have a greaer demand for conservaism. A number of measures of aggregae conservaism have been proposed, wih he Basu, (997) asymmeric imeliness measure being he mos prominen one (Ryan, 6). Invesors pu heir decision based on balance beween risk and reurn. They are ineresed o esimae he expeced reurn of fuure invesmen by informaion repored by company and oher evidences. igher qualiy informaion resuls o lower ambiguiy in esimaing he expeced reurn and risk of informaion will be reduced. Capial cos is considered based on wo dimensions: inra-organizaional and exra-organizaional. From exraorganizaional view poin, capial cos is used in evaluaing securiies and company performance and from inraorganizaional view poin. Capial cos has a key role in decisions relaing o invesmen and invesmen prioriies, opimal srucure of capial and performance evaluaion. Cos of capial is defined concepually in connecion wih he expeced reurn in oher words. Capial cos is so called a minimum expeced rae of reurn. If i is lower han capial cos, he value of economic unis will be reduced. Therefore, managers desire o mainain he value of economic reurn should ry o reach he expeced reurn a leas o he capial cos. ere he key o success is o reduce capial cos. If he managers become successful o reduce capial cos of he economic uni, he excess expeced reurn resuled from performing a profiable projec which is no profiable for economic unis compeing wih higher capial cos, will add value o he economic cos. I should be noed ha he company should reduce invesmen risk o reduce is capial cos and o increase shareholders wealh. One of he componens of invesmen risk in a company is is informaional risk. I means more conservaive and higher qualiy and accuracy of informaion provided by he company. Lower informaional risk from he view poins of invesors. Therefore, qualiy of repored informaion is crucial for managers. Thus, he conservaive is a very imporan maer. Skip o main purpose of he company (increasing shareholders wealh) i will be deermined ha sudying conservaism effec on capial cos of common sock is very imporan for managers o reach heir main goal by deermining effec of conservaism on capial cos of common sock. Conservaism in financial repor is produced as a resul of some economic reasons ha will be formaed in four explanaions: - Formal explanaion - Explanaion of legal claims 3- Tax explanaion 4- Explanaion of accouning rules and regulaions Among he four menioned above, formal explanaion is older han he oher once, so ha Was, (3) beliefs has been used for cenuries in accouning. So anyone can presen poin in recen hisory since hen he influence of he agreemen has sared. In conras, he ohers hree explanaion are based on more recen

3 Aus. J. Basic & Appl. Sci., 6(): -8, phenomenon and are able o explain conservaism. owever resuls of invesigaion represen he imporance of all of hem. Inerrelaing beween hese four explanaion represen hey may emanae a single explanaion of conservaism and common feaures of all of hese economic facors is in an asymmerical loss funcion. So far, some criicism has been done by groups such as acivaes in capial marke, sandard marker, and academic researchers on conservaism which he resuls as following:. Disrus,. secrecy, 3. denial of accouning principles, 4. Bias, and 5. menal maer. Defense made for conservaism is ha he senior managers are responsible for preparing financial saemens and hey have complee knowledge abou financial saus of he company and have more awareness and wih he aim of collecing more financial resources and required capial, hey have differen moivaion consis of moivaion of invesors and crediors. Naurally, managers end o be very opimisic abou he business uni and if hey are asked abou financial saus of he company, hey will answer i are in a bes condiion. For example, o reduce coss and o increase profis, hey idenify cos of a period as asses. Under such condiions, conservaism is used as a principle of limiing accouning and i is used o moderae manager opimism and o proec he righs of shareholders. Conservaism principle has caused a mehod will be seleced and applied among differen choose which has he leas addiive influence on ne profi and oal asses of he company. Crieria of Conservaism Evaluaion: In a real sense i can used hree crieria for evaluaing conservaism as following: - Ne asse crieria. - Crieria of accrual iems and profi. 3- Crieria of relaion beween sock profi and reurn. Ne Asse Crieria: Alhough marke value of asses and deb ha consiue he ne asses change in each course, all of hese don reflec in financial repors and accouns. Based on conservaism increasing in he value of asse (profis) ha isn enough o confirm won be recorded while he reducion in he value of asses (losses) wih he same degree of confirming will be recorded. As a resul, ne asses will be represened wih he value less han heir marke value. In esimaing his represenaion, ha i can be used acually less sock assessmen model for business unis or proporion of book value of ne asses o heir shares value (raio of book value o marke value) Crieria of Accrual Iems and Profi: Conservaism indicaes ha profis are more sable han losses because financial saemens can idenify insuscepible increasing in ne asse value a he ime of occurrence. Crieria of Relaion Beween Sock Profi and Reurn: The price of sock marke indicaes changes of asse value when changes occur wheher hey include losses or profis from asse value. So we can say sock reurns are always opporune. Since conservaism expecs ha he basis for idenificaion of accouning losses is imelier han profis so i is expeced ha accouning losses has more ime symmery wih sock reurn han he accouning profis. Using hese principles, Bassu, (997) inroduced a crierion so called ime asymmery of profi which will be discussed in he nex pars. Financing decisions: Decisions concerning financing needed for insiuion are he mos imporan financial decisions. The imporan of hese decisions and is effecs on financial srucure of he insiuion and ulimaely he ineress of invesors is o he exen ha any decision if his ype is considered sraegic decision of a company should ensure ha financing of which mehods could beer supply fuure ineres of he company. Task of each financial manger is opimizing he srucure of asses, debs, equiies o maximize shareholders wealh. Therefore, financial manager can affec shareholders wealh hrough changing for example in profi per share a presen and fuure, ime scheduling and risk profiabiliy, policy of profi sharing and choice of financing mehod. Generally, here are four main sources of financing for profi unis as follow: - Borrowing. - Issuing preferred socks. 3- Issuing common socks. 4- Using of reained earning. 3

4 Aus. J. Basic & Appl. Sci., 6(): -8, Borrowing and releasing common and privileged sock have common feaures means ha financing is ouside of profi uni and is operaions. While he cumulaive profi represens a domesic sources of financing. Financing hrough releasing common sock and using accumulaed ineres have a common feaure, oo; because hey represen he gran funds by owner of profi uni. Financing Through Borrowing (deb): When a profi uni supplies he required funds by borrowing, i is necessary o commi repaymen of principal and profi of he borrowing. The erms and procedure of repaying borrowing and paging is coss are usually refleced in he respecive conrac. Preferred Sock: Preferred sock has some feaure ha makes i o place beween he financing mehods hrough borrowing and common sock. Preferred sock is similar o borrowing in erms of being given he same amoun or prior o paymen of common revenue. Righs of preferred shareholders are kep hrough some characerisic ha is usually refleced in he agreemen of he preferred sock. Common Sock: Common sock is a kind of financial asses ha represens ownership in a company and some feaure of common sock include propery righ, he righ o voe, conrol of company and prioriy in buying new shares. These papers is a major source of financing companies and releasing hese papers has is own specific condiions (according o each counry) and is difference wih he oher wo financing sources is ha he propagaor companies will no pay any ineres or fixed annual profi per share and hose who are buying hese securiies are involved in profiabiliy and revenue as a resul of company operaions. Profi unis can supply he required funds hrough issuance and sale of common sock o invesors who were shareholders before or hey become shareholder by buying new shares. As menioned before, ordinary shareholders have he righ o hae as profi uni owners and hrough his in public assemblies, board of direcors are seleced. Financing Through Reained Earning: Reained earning consiss of remaining in a profi uni afer he dividend is paid, bu financing hrough reained earning will reduce dividend payable o he presen shareholders Review of Lieraure: Xili, (9) invesigaed he relaionship beween conservaism and cos of capial and he found ou more conservaism has resuled in reducion of capial cos of debi. Beay and Weber, (5) also confirmed resuls of researches were done before and hey showed ha conflic of ineres beween shareholders and crediors in borrowing conracs will increase using conservaism in financial reporing. Francis, Olson, and Schipper (3) invesigaed relaionship beween suiabiliy and conservaism as wo feaures of income wih capial cos and discovered he imporance of he raios. Research ypohesis: According o above menioned lieraure he main is posulaed as following: There is a significan relaionship beween conservaism and he capial cos of he common sock. Therefore, he overall research model is as follows: CEj MTBj. CONj. j. Wih regard o he main hypohesis wo sub-hypoheses are as following: Firs sub-hypohesis: There is a significan relaionship beween ime asymmery of profi and he capial cos of he common cos. Second sub-hypohesis: There is a significan relaionship beween he raio of marked value o he book value in he end of esimaed course and he capial cos of he common sock. Research Mehodology: In his sudy, he relaionships beween variables are analyzed based on he objecive of he research. Correlaion sudies can be divided in o hree caegories based on he objecive: 4

5 Aus. J. Basic & Appl. Sci., 6(): -8, A: wo variables correlaion sudies B: regression analysis C: analysis of covariance or correlaion marix Wih regard o invesigaing he relaionship beween conservaism and he capial cos of he common sock, and evaluaing he relaionship beween ime asymmery of profi and he capial cos and he raio beween marke value o book value wih he capial cos of he common sock, so in performing his research, variables correlaion sudy and regression analysis were used. Populaion of he Sudy: Companies lised in Tehran Sock Exchange have considered he populaion of he sudy. The saisical sample is seleced on he basis of he following condiions: A: hese companies should be raded a he beginning of 6. B: Trading of he share of hese companies shouldn be sopped in sock exchange during 6-9. In he oher words, he share of hese companies should be acive during he years menioned. C: Required access o he financial saemens should be possible. Considering he above condiions among all companies which are lised in Tehran Sock Exchange, 5 companies were seleced as sudy samples. Research Variables: Raio of profi o he sock price (E/P), cos of capial of common sock are used as dependen variables. In his sudy, independen variables are sock reurn (R) and mark value o he book value. Regarding o he calculaion of he raio of profi o he sock price (E/P) Basu, (997) used soke reurns o evaluae news and using regression beween profi and sock reurn, he foun ou ha he response of profi relae o bad news was more imely han he response of profi relae o good news: E / P a DR R R DR Where E = profi in he year. P-= he marked price of sock a he beginning of year. R T : sock reurn in he year. DR = I is an index ha if R is negaive, i will equal o one and if i is posiive, i will equal o zero. Calculaion Common Sock Invesmen Cos: Esimaed cos of common sock, financial srucure is relaed more o he company aciviies, for calculaing he cos of common sock, following simple relaionship can be used: Cos of common sock = curren profi divided by marked price/marke price. Mehod of Divided Profi (Gordon model): For esimaing he cos of common sock of a company more accuraely, price sensiiviy and performance of curren and fuure demands of shareholders should be esimaed in his regard," cash dividend assessmen model" can be used and he following formula can be uilized: p o D Ke y po Up o dae price of he cash sock D = divided profi a he firs par o he year. Ke= common shareholders expeced rae of reurn. y= growh rae of cash divided equivalen o geomeric mean of growh rae of divided profi. By displacing he above formula, he expeced rae of reurn (Ke) or in oher words, he rae of common sock from cumulaive profi can be calculaed as follows. D ke g P Calculaions of sock reurn (R) Sock reurn from mainenance and purchase is equal o sock price changes and cash benefis, shares divided by sock price a he beginning of he period. 5

6 Aus. J. Basic & Appl. Sci., 6(): -8, R D p ( ) ( p p c C) * P = he share price a end of. P - = he share price in he firs period. D = he approved cash profi in he firs of per share in he firs period of. = Raio of increasing capial from demands and brough cash. : Raio of increasing capial from reserve. C: amoun of money paid nominally per share by invesors for increasing capial from demands and brough cash. Raio of marke value o he book value of sock (MTB): Raio of MTB is a crierion for measuring conservaism which includes he resul dividing sock marke value o is book value. Denominaor of his raio is he resul of dividing equiies of shareholders in balance shee by he number of common sock of he company (MTB is calculaed per share). Tesing of Main ypohesis: Using correlaion analysis and by referring o he ables of oupu informaion of SPSS. We can sugges abou he companies as follows: = There is no meaningful relaionship beween conservaism and invesmen cos of common sock. = There is a meaningful relaionship beween conservaism and invesmen cos of common sock. Esimaed regression equaion is as follows: ce MTB.579E / P r.45 R.3 Meanwhile, he overall equaion is composed of hree variables CE, MTB and E/P ha in he above equaion based in Table. E/P is meaningful and MTB isn meaningful. Table : The resuls of hree variables. Model T p-value Resul <. significan MTB insignifican E/P <. significan As observed in Table. ypohesis is rejeced a.5 significance level; as correlaion coefficiens, r=.45, is moderae, herefore i can be concluded ha here is a negaive relaionship beween conservaism cos of common sock. Bu his relaionship regarding given low coefficien(r) seems o be average. Table 3: resul of he main hypohesis. ypohesis P-value R resul rejeced Tesing of sub-hypoheses As i was explained in before, conservaism is assessed in hree ways which in sub- hypoheses. Conservaism is assessed in wo ways MTB and E/P, and hen is relaionship wih invesmen cos is reviewed Firs sub-hypohesis esing = There is no significan relaionship beween asymmeric imeliness profis and invesmen cos of common sock. Esimaed regression equaion is as follows: 6

7 Aus. J. Basic & Appl. Sci., 6(): -8, CM= MTB r=.439 R. 93 As is seen in Table 3, hypohesis is rejeced in he significance level of.5 and regarding correlaion coefficien r=.439, i is average. Therefore, i can be concluded ha here is a significance relaionship beween asymmeric imeliness profis and invesmen cos of common sock, bu regarding low coefficien (r), i seems o be average. Table 3: Resuls of he firs sub-hypohesis esing. ypohesis P-value R R resul Rejeced Tesing of second sub-hypohesis : There is no significan relaionship beween he raio of marke value o book value and invesmen cos of common sock. : There is significan relaionship beween he raio of marke value o book value and invesmen cos of common sock. Esimaed regression equaion is as follows: CE=.8 -. MTB r=.49 R =.6 As is seen in Table 4, hypohesis is rejeced in he significan level of.5 and regarding correlaion coefficien is r=.49 so i is weak. Therefore, i can be concluded ha here is a significan relaionship beween he raio of marked value o book value and invesmen cos of common sock, bu his relaionship seems o be weak regarding low coefficien (r).\ Table 4: Resuls of he second sub-hypohesis esing. ypohesis P-value R R resul Rejecion Conclusion: In analyzing he main research hypohesis, i is observed ha here is no srong relaionship beween conservaism and invesmen cos of common sock based on he correlaion coefficien and he relaionship. Analysis of research secondary hypohesis In analyzing he firs sub-hypohesis, i is observed ha here is a meaningful and srong relaionship beween CE and E/P based a correlaion coefficien and deermining and i is an average relaionship. Also, in analyzing he relaionship beween variables in he period of he sudy, he resul has been rejeced in all years. In analyzing he second hypohesis, i is observed ha here is no significan and srong relaionship beween CE and MTB based on correlaion coefficien and deermining and heir relaionship is weak. Limiaions of he Sudy: Cerainly in doing each research, researcher will encouner obsacles and problems ha his research also has no been excluded. The mos imporan of hese problems include: - Direc resources limiaion. - Problem in daa collecion. Suggesion for Fuure Researches: - Regarding crieria of conservaism assessmen which include hree ypes (crieria of ne asses, crieria of profi and commimen iems, crieria of relaion beween profi and sock reurn). In his sudy, he firs hird crieria are used. Therefore, i is recommended o perform a research for specifying he relaionship beween he crieria of profi and commimen iems wih invesmen cos of common sock. - Sudying he relaionship beween conservaism and dep. 7

8 Aus. J. Basic & Appl. Sci., 6(): -8, 3- Sudying he relaionship beween conservaism and privileged shares. 4- Sudying he relaionship beween conservaism and financial raios. 5- Sudying he relaionship beween conservaism and companies profiabiliy. 6- Sudying he relaionship beween conservaism and invesmen cos in differen indusries. REFERENCES Ahmed, A.S., BK, Billings, R.M., Moron and M., Sanford-arris,. The Role of Accouning Conservaism in Miigaing Bondholder-Shareholder Conflics over Dividend Policy and in Reducing Deb Coss, The Accouning Review, 77(4): Basu, S., 997. The Conservaism Principle and he Asymmeric Timeliness of earning, Journal of Accouning & Economic, 4: 337. Basu, S., 997. The conservaism principle and he asymmeric imeliness of earnings. Journal of Accouning and Economics, 4(): Beay, A. and J. Weber, 5. Accouning Discreion in fair value esimaes: An examinaion of SFAS 4 goodwill impairmens, forhcoming. Journal of Accouning Research. Beaver, W., 998. Financial Reporing: An Accouning Revoluion, 3rd Ediion, Upper Saddle River, NJ: Prenice-all. Beaver, W.. and S.G. Ryan, 5. Condiional and Uncondiional Conservaism: Conceps and Modeling, Review of Accouning Sudies, (/3): Francis, J., R. LaFond, P.M. Olsson and K. Schipper, 4. Coss of Equiy and Earnings Aribues, The Accouning Review, 79(4): Francis, J., R.Z. Lafond, P. Olsson and K. Schipper, 3. Coss of capial and Earnings Aribues, available a: hp://papers.ssrn.com/sol3/papers.cfm?absrac_id=54437 Givoly, D., C.K. ayn and A. Naarajan, 7. Measuring reporing conservaism. TheAccouning Review, 8(): Kieso, D.E., J.J. Weygand and T.D. Warfield, 6. Inermediae Accouning. h Ediion, John Wiley & Sons, Inc. LaFond, W. and R.L. Was, 8. The informaion role of conservaism. The Accouning Review (forhcoming). Penman, S. and X. Zhang,. Accouning Conservaism, Qualiy of Earnings, and Sock Reurns, The Accouning Review, 77: Roychowdhury, S. and R.L. Was, 7. Asymmeric imeliness of earnings, marke-o-book and conservaism in financial reporing. Journal of Accouning and Economics, 44: -3. Ryan, S., 6. Idenifying condiional conservaism, European Accouning Review, 5(4): Was, R.L., 3. Conservaism in Accouning Par II: Evidence and Research Opporuniies, Accouning orizons, pp: Xi Li., 9. Accouning Conservaism and Cos of Capial, available a: hp://papers.ssrn.com/sol3/papers.cfm?absrac_id=697 8