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Accounting Conservatism and the Efficiency of Debt Contracts

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Author Info
FRANK GIGLER
CHANDRA KANODIA
HARESH SAPRA
RAGHU VENUGOPALAN
Abstract

ABSTRACTIn this paper we examine how accounting conservatism affects the efficiency of debt contracting. We develop the statistical and informational properties of accounting reports under varying degrees of conditional and unconditional accounting conservatism, consistent with Basu's [1997] description of differential verifiability standards. Optimal debt covenants and interest rates on debt are derived from a natural tension between debt holders and equity claimants. We show how optimal covenants vary with the degree of conservatism and derive an efficiency metric that depends on the degree of conservatism. We find that accounting conservatism actually "decreases" the efficiency of debt contracts, contrary to the suggestions of Watts [2003] and contrary to the hypothesis in numerous empirical studies. Copyright (c), University of Chicago on behalf of the Institute of Professional Accounting, 2009.

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Article provided by Blackwell Publishing in its journal Journal of Accounting Research.

Volume (Year): 47 (2009)
Issue (Month): 3 (06)
Pages: 767-797
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Handle: RePEc:bla:joares:v:47:y:2009:i:3:p:767-797

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  1. Hirshleifer, David & Teoh, Siew Hong, 2009. "The Psychological Attraction Approach to Accounting and Disclosure Policy," MPRA Paper 14046, University Library of Munich, Germany. [Downloadable!]
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This page was last updated on 2009-12-19.

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