Firm's cost of debt firstly changes conservatism and then leads the choices of future diversification strategies: Evidence from Asian countries

• Published date: 01 April 2023
• Author: Sumiyana Sumiyana,Vivi Usmayanti
• Date: 01 April 2023
• DOI: http://doi.org/10.1002/jcaf.22606

Received:  June  Revised:  November   Accepted:  November 

DOI: ./jcaf.

RESEARCH ARTICLE

Firm’s cost of debt firstly changes conservatism and then

leads the choices of future diversification strategies:

Evidence from Asian countries

Sumiyana Sumiyana Vivi Usmayanti

Department of Accounting, University of

Gadjah Mada, Yogyakarta,Indonesia

Correspondence

Sumiyana Sumiyana, University of

Gadjah Mada, Yogyakarta,Indonesia.

Email: sumiyana@ugm.ac.id

Abstract

This study investigates how firms’ debt cost affects their conservatism in the

first stage, and then leads their future strategies in the second stage. Moreover,

it shows that firms would likely ignore their conservatism when choosing a

strategy, especially diversification. Then, it presents two interrelated novelties.

First, firms operate with a low cost of debt, constructing their high conservatism.

As a result, they would likely choose a cost-reduction strategy. Conversely,

firms with low conservatism usually choose diversification strategies because

they are at the lowest risk. Second, this study highlights that the firms’ diver-

sification strategies are a conundrum while considering the cost of debt and

conservatism when applied by firms operating the business in developing coun-

tries. Operating in emerging economies, firms could choose a higher debt cost

and simultaneously ignore conservatism, maintaining their creditors as funding.

Moreover, this research examines Asian countries’ data using ordinary least-

square (OLS) and two-stage last-square (-SLS). In addition, -SLS outperforms

in the staged-associative examinations. Thus, this research reveals that the cost

of debt, conservatism and chosen strategies relate to simple staging. As a result,

they acquire the highest cost of debt, with the high-risk level affecting their

weighted cost of capital. Finally, this research infers that firms’ costs of debt

and conservatism are not mutually exclusive and sequentially affect their future

strategic choices. It, therefore, suggests that when firms choose diversification

strategies, they might probably take a high cost of debt, accompanied by a highly

conservative level.

KEYWORDS

conditional, conservatism, cost of debt, diversification, firms’ strategy

JEL CLASSIFICATION

M Accounting, M International Business Administration, I firm performance, size,

diversification, and scope

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproductionin any medium, provided the

original work is properly cited.

©  The Authors. Journalof Corporate Accounting & Finance published by Wiley Periodicals LLC.

242 wileyonlinelibrary.com/journal/jcaf JCorp Account Finance. ;:–.

SU MIYAN A  US MAYAN TI 243

1BACKGROUND

This study highlights that a firm should continually

innovate its organizational and product developments to

become the leading industry or nation. Moreover, it posits

Kung et al. ()andHittetal.() by suggesting that

firms’ diversification supports their growth and increases

their conglomeration process. However, the firms usually

have been constrained by their limited resources. Conse-

quently,they should acquire funds from outside that could

finance their diversification agendas (Lara et al., ).

Moreover,the authors consider Fernando et al. (), who

suggested that firms positing diversification strategies are

those with low accounting conservatism. Therefore, this

research investigates the association between the cost of

debt, conservatism, and diversification. Meanwhile, this

association is in two stages; the cost of debt influences

conservatism and further affects the formulation of a strat-

egy. To extend, the cost of debt with conservatism leads

CEOs to employ strategic diversification. Moreover, this

study continually investigates the impact of low conser-

vatism and the high cost of debt in Asian countries due

to their high economic volatility. By these mean, this

study argues that Asian firms are heavily biased toward

being conservative and implement diversification strate-

gies whether they maintain their sustainable adaptations

or not.

This research has uniqueness supported by its critical

reasoning, as stated below. First, firms operate with a low

cost of debt to construct their high conservativeness. This

study argues that firms with low conservatism usually

choose diversification strategies because they act aggres-

sively to gain market dominance, penetration, or other

reasons. Moreover, it explains that a firm’s risk within a

diversification strategy will be minimal. Thus, the firm’s

diversification strategy is aligned with its conservative pol-

icy. In other words, the firm’sconservatism forces its CEO

to formulate a diversification strategy. Furthermore, this

research posits Kim and Reinschmidt (), suggesting

that firms’ diversification strategies affect their corporate

risk because they could achieve broader market areas or

sell new products. Thus, the authors demonstrate that

these firms gain market dominance that probably ignores

their conservatism by acquiring new debts at high-interest

rates.

Second, this study highlights that a firm’s diversifica-

tion strategy is a conundrum when considering the cost of

debt and conservatism implemented in developing coun-

tries. Moreover,it shows the logic of Kung et al. ()and

Vichitsarawong et al. (), who stated that most Asian

firms tighten or weaken their conservatism after a crisis.

In addition, these firms’ conservative choices likely ignore

their cost of debt as an opted consequence. Hence, this

study supports this argument with the economic volatil-

ity and uncertainty of most Asian firms in the developing

world. In other words, most firms in developing countries

will not take risks, so they should consider a highly con-

servative approach. Therefore, when firms in developing

countries implement a diversification strategy, they face a

higher risk level than those in developed countries.

Third, this study explains that the firms could choose a

higher cost of debt because of their conservatism and igno-

rance (Chan & Hsu, ). On the other hand, this study

argues that these firms take other funds from related or

outside creditors. Consequently,these firms should protect

their creditors; they do not want to acquire the highest cost

of debt with a high-risk level and have this affect their costs

of equity capital. Nevertheless, a firm’s conservatism offers

an advantage to creditors, protecting them from the poten-

tial risk from their invested funds (Ball & Shivakumar,

). Therefore, this research argues that a CEO consid-

ers the firm’s past performance from its operational and

financing risks, leading to a diversification strategy.Hence,

it confirms the theory of Beatty et al. () regarding

measuring firms’ operational and financial risks, including

their future performances.

Fourth, this study offers the methodological refine-

ment (Chkir & Cosset, ;Dengetal.,;Franco

et al., ) that a firm’s debt costs affect its decision to

implement its diversification strategy. Moreover, this firm

should consider its conservatism concerning the cost of

debt impacting its diversification strategy. In other words,

the authors argue that these associations between the

cost of debt, conservatism and the diversification strategy

are staged relationships. Therefore, this study demon-

strates that a firm’s cost of debt affects its conservatism;

after that, the collaborating two factors cause the CEO

to opt for a diversification strategy. Then, it develops a

-SLS staging association (Boulton et al., ; Sumiyana

& Setyowati, ;Wangetal.,). Hence, this study

comprehends that the CEO’s perspective considers the

staging association, the first adoption of debt costs that

reduce the long-term risks and supports them to opt for a

diversification strategy.

This study uses assumptions to support the achieve-

ment of its propositions. First, this study takes accounting

conservatism to the firm-level position. It means that the

conservatism level came from the CEO’s policies. In other

words, this study does not apply firms’ conservatism influ-

enced by implementing accounting standards or other

regulations. Second, this study does not consider market-

wide regime shifting behavior (Ho & Sequeira, ),

nor does it assume using a firm-specific model. Finally,

this study does not explicitly use market-wide regime-

shifting behavior, as industrial and national performances

influence the firms’ accounting conservatism.