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Corporate Debt Financing and Earnings Quality

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  • Aloke (Al) Ghosh
  • Doocheol Moon
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    Abstract

    Our study establishes linkages between two extensively researched areas, debt financing and the quality of earnings. Debt can have a 'positive influence'on earnings quality because managers are likely to use their accounting discretion to provide private information about the firms' future prospects to lower financing costs. For high debt, it can also have a 'negative influence' on earnings quality as managers use accruals aggressively to manage earnings to avoid covenant violations. Using accruals quality as a proxy for earnings quality, we document a non-monotonic (curvilinear) relation between debt and earnings quality. The relationship is positive at low levels of debt and negative at high debt levels with an inflection point around 41%. Our results suggest that firms that rely heavily on debt financing might be willing to bear higher costs of borrowing from lower earnings quality because the benefits from avoiding potential debt covenant violations exceed the higher borrowing costs. Copyright (c) 2010 Blackwell Publishing Ltd.

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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1468-5957.2010.02194.x
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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Journal of Business Finance & Accounting.

    Volume (Year): 37 (2010-06)
    Issue (Month): 5-6 ()
    Pages: 538-559

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    Handle: RePEc:bla:jbfnac:v:37:y:2010-06:i:5-6:p:538-559

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    Web page: http://www.blackwellpublishing.com/journal.asp?ref=0306-686X

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    Cited by:
    1. García-Teruel, Pedro J. & Martínez-Solano, Pedro & Sánchez-Ballesta, Juan Pedro, 2014. "The role of accruals quality in the access to bank debt," Journal of Banking & Finance, Elsevier, vol. 38(C), pages 186-193.

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