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Accounting quality, debt covenant design, and the cost of debt

Author

Listed:
  • Charlene P. Spiceland

    () (The University of Memphis)

  • Leo L. Yang

    () (University of Miami)

  • Joseph H. Zhang

    () (The University of Memphis)

Abstract

Abstract We examine whether debt covenant design (threshold tightness, covenants frequency, covenant interdependence, and overall covenant strictness) reduces the adverse effect of poor accounting quality on the cost of debt in the private lending market. We predict and find that when borrowing firms exhibit low accounting quality, lenders tend to increase debt contract strictness through debt covenant design (e.g., increasing the number of covenants, decreasing covenant interdependence or including covenants with greater threshold tightness). Moreover, our results indicate that the cost of debt for borrowers with low accounting quality is significantly influenced by the covenant strictness. Further evidence shows that, although debt covenant designs help mitigate adverse information risk, financial reporting quality is more important than strict debt covenants in lowering the cost of debt, a matter of concern for firm managers and lenders.

Suggested Citation

  • Charlene P. Spiceland & Leo L. Yang & Joseph H. Zhang, 2016. "Accounting quality, debt covenant design, and the cost of debt," Review of Quantitative Finance and Accounting, Springer, vol. 47(4), pages 1271-1302, November.
  • Handle: RePEc:kap:rqfnac:v:47:y:2016:i:4:d:10.1007_s11156-015-0538-9
    DOI: 10.1007/s11156-015-0538-9
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    References listed on IDEAS

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    1. repec:kap:rqfnac:v:52:y:2019:i:1:d:10.1007_s11156-018-0708-7 is not listed on IDEAS
    2. repec:kap:rqfnac:v:51:y:2018:i:3:d:10.1007_s11156-017-0686-1 is not listed on IDEAS
    3. repec:eee:bracre:v:51:y:2019:i:4:p:373-401 is not listed on IDEAS

    More about this item

    Keywords

    Accounting quality; Debt covenants; Covenant strictness; Cost of debt;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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