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Accounting standards and debt covenants: Has the “balance sheet approach” led to a decline in the use of balance sheet covenants?

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  • Demerjian, Peter R.

Abstract

Recent years have seen a sharp decline in the use of balance sheet-based covenants in private debt contracts. I hypothesize that changes in accounting standards can explain part of this decline. Standard setting has shifted towards a “balance sheet approach”, which I predict has made the balance sheet less useful for contracting. I measure the effect of the balance sheet approach on specific borrowers using a volatility ratio. I find that borrowers with greater volatility ratios are less likely to have balance sheet-based covenants. This evidence is consistent with reductions in the contracting usefulness of the balance sheet being associated with reductions in balance sheet covenants.

Suggested Citation

  • Demerjian, Peter R., 2011. "Accounting standards and debt covenants: Has the “balance sheet approach” led to a decline in the use of balance sheet covenants?," Journal of Accounting and Economics, Elsevier, vol. 52(2), pages 178-202.
    • Handle: RePEc:eee:jaecon:v:52:y:2011:i:2:p:178-202
    DOI: 10.1016/j.jacceco.2011.08.004
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    More about this item

    Keywords

    Debt contracting; Covenants; Accounting standards; Balance sheet;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M48 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Government Policy and Regulation

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