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Hedge commitments and agency costs of debt: evidence from interest rate protection covenants and accounting conservatism

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  • Anne Beatty

    (The Ohio State University)

  • Reining Petacchi

    (Massachusetts Institute of Technology)

  • Haiwen Zhang

    (The Ohio State University)

Abstract

We provide large sample evidence that credible hedge commitments reduce the agency costs of debt and that accounting conservatism enhances hedge commitments. We examine 2,338 bank loans entered into by 263 mandatory derivative users that are contractually obligated by interest rate protection covenants, 709 voluntary derivative users, and 1,366 non-users. We show that loan contracts are more likely to include interest rate protection covenants when borrowers are less likely to maintain the hedge position once the financing is completed. We find that borrowers who credibly commit to hedge using these covenants significantly reduce their interest rates. While we do not find an average interest savings for voluntary derivative users, we do find a reduction in their loan rates when they practice conservative financial reporting. Our results suggest that accounting conservatism helps borrowers resolve shareholder-creditor conflicts by committing to maintain their hedge positions after completing debt financing.

Suggested Citation

  • Anne Beatty & Reining Petacchi & Haiwen Zhang, 2012. "Hedge commitments and agency costs of debt: evidence from interest rate protection covenants and accounting conservatism," Review of Accounting Studies, Springer, vol. 17(3), pages 700-738, September.
    • Handle: RePEc:spr:reaccs:v:17:y:2012:i:3:d:10.1007_s11142-012-9189-4
    DOI: 10.1007/s11142-012-9189-4
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    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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