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Debt Covenants and Accounting Conservatism

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  • VALERI V. NIKOLAEV
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    Abstract

    ABSTRACT Using a sample of over 5,000 debt issues, I test whether firms with more extensive use of covenants in their public debt contracts exhibit timelier recognition of economic losses in accounting earnings. Covenants govern the transfer of decision-making and control rights from shareholders to bondholders when a company approaches financial distress and thereby limit managers' abilities to expropriate bondholder wealth. Covenants are expected to constrain managerial opportunism, however, only if the accounting system recognizes economic losses in earnings in a timely fashion. Thus, the demand for timely loss recognition should increase with a contract's reliance on covenants. Consistent with this conjecture, I find evidence that reliance on covenants in public debt contracts is positively associated with the degree of timely loss recognition. I also find evidence that the presence of prior private debt mitigates this relationship. Copyright (c), University of Chicago on behalf of the Accounting Research Center, 2009.

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

    Volume (Year): 48 (2010)
    Issue (Month): 1 (03)
    Pages: 51-89

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    Handle: RePEc:bla:joares:v:48:y:2010:i:1:p:51-89

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    Cited by:
    1. Andreas Engert & Lars Hornuf, 2013. "Market Standards in Public Sector Debt Contracting," CESifo DICE Report, Ifo Institute for Economic Research at the University of Munich, Ifo Institute for Economic Research at the University of Munich, vol. 11(3), pages 16-20, October.
    2. Lawrence, Alastair & Sloan, Richard & Sun, Yuan, 2013. "Non-discretionary conservatism: Evidence and implications," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 56(2), pages 112-133.
    3. Chen, Jeff Zeyun & Lobo, Gerald J. & Wang, Yanyan & Yu, Lisheng, 2013. "Loan collateral and financial reporting conservatism: Chinese evidence," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4989-5006.
    4. Cline, Brandon N. & Garner, Jacqueline L. & Yore, Adam S., 2014. "Exploitation of the internal capital market and the avoidance of outside monitoring," Journal of Corporate Finance, Elsevier, Elsevier, vol. 25(C), pages 234-250.
    5. Roychowdhury, Sugata & Martin, Xiumin, 2013. "Understanding discretion in conservatism: An alternative viewpoint," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 56(2), pages 134-146.
    6. Hornuf, Lars & Engert, Andreas, 2013. "Can Network Effects Impede Optimal Contracting in Debt Securities?," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79867, Verein für Socialpolitik / German Economic Association.
    7. Marco Fasan & Carlo Marcon, 2014. "Accounting Tradition and other drivers of the Fair Value choice: An Opportunistic Management perspective," Working Papers 13, Department of Management, Università Ca' Foscari Venezia.
    8. Badertscher, Brad A. & Collins, Daniel W. & Lys, Thomas Z., 2012. "Discretionary accounting choices and the predictive ability of accruals with respect to future cash flows," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 53(1), pages 330-352.

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