Determinants of Financial Conservatism

Abstract This paper investigates the phenomenon of financial conservatism, which is defined as the policy of extremely low debt, its determinants, and the magnitudes of their effects in the context of Russian market. The sample used in the study covers years from 2006 to 2016 and incorporates 682 Russian firms with the main source of data being Buro van Dijk database Ruslana. The study employs the binary response variable approach, which characterizes firm as financially conservative if its leverage ratio if lower than a certain cut-off level. In order to provide robust results, four distinct definitions of leverage are employed as well as several cut-off levels. The results posit that the higher likelihood of financial conservatism is associated with greater financial constraints, higher demand for financial flexibility, and considerable managerial entrenchment. The propositions of the trade-off theory and the pecking order theory are, on the contrary, rejected in general, while the effect of profitability is unclear and changes under different leverage definitions. The impact of the macroeconomic factors is rejected as well based on the regression analysis. Among the significant factors, the largest effect is caused by firm size followed by assets tangibility, cash holdings, and the managers’ ownership of the firm. Additionally, the performed analysis points at significant differences in the numbers of conservative observations between industries and characterizes extreme debt-aversion as a short-term policy which lasts between 1 and 4 years.