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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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    References listed on IDEAS

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    Cited by:

    1. Lim, Steve C. & Mann, Steven C. & Mihov, Vassil T., 2017. "Do operating leases expand credit capacity? Evidence from borrowing costs and credit ratings," Journal of Corporate Finance, Elsevier, vol. 42(C), pages 100-114.
    2. Bannier, Christina E. & Wiemann, Markus, 2014. "Performance-sensitive debt: The intertwined effects of performance measurement and pricing grid asymmetry," CFS Working Paper Series 476, Center for Financial Studies (CFS).
    3. Liangliang Jiang & Hui Zhou, 2017. "The role of audit verification in debt contracting: evidence from covenant violations," Review of Accounting Studies, Springer, vol. 22(1), pages 469-501, March.
    4. Prilmeier, Robert, 2017. "Why do loans contain covenants? Evidence from lending relationships," Journal of Financial Economics, Elsevier, vol. 123(3), pages 558-579.
    5. repec:eee:jaecon:v:64:y:2017:i:2:p:253-277 is not listed on IDEAS
    6. repec:eee:corfin:v:45:y:2017:i:c:p:540-565 is not listed on IDEAS
    7. repec:eee:jaecon:v:64:y:2017:i:2:p:221-245 is not listed on IDEAS
    8. Masaki Kusano, 2012. "Does the Balance Sheet Approach Improve the Usefulness of Accounting Information?," The Japanese Accounting Review, Research Institute for Economics & Business Administration, Kobe University, vol. 2, pages 139-152, December.
    9. Dan Givoly & Carla Hayn & Sharon Katz, 2017. "The changing relevance of accounting information to debt holders over time," Review of Accounting Studies, Springer, vol. 22(1), pages 64-108, March.
    10. KOCHIYAMA, Takuma & NAKAMURA, Ryosuke, 2014. "Role, Structure, and Determinants of Debt Covenants: Evidence from Japan," Working Paper Series 187, Center for Japanese Business Studies (HJBS), Graduate School of Commerce and Management Hitotsubashi University.
    11. Tan, Liang, 2013. "Creditor control rights, state of nature verification, and financial reporting conservatism," Journal of Accounting and Economics, Elsevier, vol. 55(1), pages 1-22.
    12. Ray Ball & Xi Li & Lakshmanan Shivakumar, 2015. "Contractibility and Transparency of Financial Statement Information Prepared Under IFRS: Evidence from Debt Contracts Around IFRS Adoption," Journal of Accounting Research, Wiley Blackwell, vol. 53(5), pages 915-963, December.
    13. repec:eee:jaecon:v:64:y:2017:i:1:p:78-97 is not listed on IDEAS
    14. repec:spr:reaccs:v:22:y:2017:i:3:d:10.1007_s11142-017-9409-z is not listed on IDEAS
    15. Hollander, Stephan & Verriest, Arnt, 2016. "Bridging the gap: the design of bank loan contracts and distance," Journal of Financial Economics, Elsevier, vol. 119(2), pages 399-419.

    More about this item

    Keywords

    Debt contracting; Covenants; Accounting standards; Balance sheet;

    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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