Accounting Conservatism and Debt Contract
Accounting Conservatism and Debt Contract

Author: Jing Li

Publisher:

Published: 2010

Total Pages: 34

ISBN-13:

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His paper develops a theoretical model to understand the role of accounting conservatism in debt contracts, incorporating the possible renegotiation of debt contracts with accounting-based covenants. I find that the demand for accounting conservatism depends on whether renegotiation occurs and if so, at what cost. When the covenant is not renegotiable or when renegotiation cost is sufficiently high, more conservative accounting actually reduces the efficiency of debt contracts. When renegotiation cost is moderate, more conservative accounting may increase the entrepreneur's welfare under certain conditions, especially for firms with less promising investment opportunities and for firms with higher liquidation values. Both are characteristics of ``traditional industriesquot; characterized by low growth and high level of tangible assets in place. When renegotiation is costless, the degree of accounting conservatism becomes irrelevant and the first best liquidation is always achieved. These results call for more cross-sectional examinations on the role of accounting conservatism in debt contracts in empirical studies.

Accounting Conservatism and Debt Contract Efficiency
Accounting Conservatism and Debt Contract Efficiency

Author: Xu Jiang

Publisher:

Published: 2017

Total Pages: 0

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This paper shows how accounting conservatism affects the efficiency of debt contracting in the presence of other non-accounting information. I show that conservative accounting will increase the efficiency of debt contracting when the other information is incrementally conservative to accounting information (the notion of incremental conservatism will be defined in the paper). However, when the non-accounting information is incrementally aggressive, conservative accounting is detrimental to the efficiency of debt contracting. Thus, whether more conservative financial reporting is good for debt contracting depends on the interaction between the informational characteristics of the accounting information and other non-accounting information. Interestingly, the result that the informational characteristics of the accounting system should be the same as those of the other information provides theoretical support for the conjecture proposed in prior studies (e.g., LaFond and Watts (2008)) -- that conservative accounting serves as a benchmark for other information sources that provide more informative information about gains. Although originated in the debt contracting framework, the conclusion that complementary information systems improves the efficiency of decision making is more general and can be adapted to any decision-making setting with correlated information sources.

Accounting Conservatism and Long-term Debt Contracts
Accounting Conservatism and Long-term Debt Contracts

Author: Aikaterini Ferentinou

Publisher:

Published: 2018

Total Pages:

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The purpose of this thesis is to examine the effect of a number of debt issue characteristics on debt contracting efficiency. After the initiation of a debt contract, inefficiencies can arise due to incomplete contracts and agency costs. I contribute to understanding whether debt maturity, different types of accounting-based (balance-sheet- and income-statement-based) debt covenants, as well as ability of renegotiation can restore efficiency. The research is motivated by the fact that there is an inconsistency in empirical and analytical results regarding the role of conservatism (beneficial or not) in the debt contracting setting. A reason for this inconsistency may well be the consideration of debt maturity. Previous analytical literature studies short-term debt contracts, while inefficiencies in the form of increased agency costs exist in case of longer debt maturity. Furthermore, analytical research does not examine balance-sheet debt covenants, although they also improve debt efficiency. My analytical show that there is a higher level of conservatism, when the long-term debt contracts include balance-sheet rather than income-statement debt covenants. Moreover, a higher level of conservatism is required under long-term than under short-term debt contracts, given that the conflict of interest between the firm and the lender is strong. My empirical findings provide empirical evidence in accordance with my analytical findings, while I also find that long-term (short-term) debt contracts include more (less) balance-sheet than income-statement debt covenants. Finally, I find that when renegotiation is an option, the intensiveness of the conflict of interest, the probability that the project is good, along with the level of renegotiation cost will determine the optimal level of conservatism. As the renegotiation cost increases, the result becomes more liberal, under a moderate conflict of interest and more conservative, under a strong conflict of interest.

Accounting Conservatism and the Efficiency of Debt Contracts
Accounting Conservatism and the Efficiency of Debt Contracts

Author: Frank Gigler

Publisher:

Published: 2009

Total Pages: 54

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In this paper we examine how accounting conservatism affects the efficiency of debt contracting. We develop the statistical and informational properties of accounting reports under varying degrees of conditional and unconditional accounting conservatism, consistent with Basu's [1987] description of differential verifiability standards. Optimal debt covenants and interest rates on debt are derived from a natural tension between debt holders and equity claimants. We show how optimal covenants vary with the degree of conservatism and we derive an efficiency metric that depends on the degree of conservatism. We find that accounting conservatism actually decreases the efficiency of debt contracts, contrary to the suggestions of Watts [2003] and contrary to the hypothesis in numerous empirical studies.

Accounting Conservatism and the Efficiency of Debt Contracts
Accounting Conservatism and the Efficiency of Debt Contracts

Author: Frank Gigler

Publisher:

Published: 2011

Total Pages: 54

ISBN-13:

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Using the debt contracting framework in Gigler et al. [2009], this paper examines the efficiency implication of accounting conservatism in the sense of timelier loss recognition. I characterize conservatism as timelier recognition of economic losses than gains for one component of the accounting signal, assuming the debt covenant is written on the whole signal reported. I show two main results. First, although information contents of accounting regimes with different timeliness in gains and losses recognition are not comparable in the Blackwell sense under my characterization of accounting regimes, the contracting efficiency always increases with timeliness in gain and loss recognition. Second, although it is true that bad news is more useful than good news for debt contracting, it is not sufficient to justify that economic losses are more useful than gains on one component of the accounting signal. My findings imply that conservatism increases the efficiency of debt contracts when the timeliness in gains recognition is fixed, which is inconsistent with the conclusions in Gigler et al. [2009].

Evidence on the Role of Accounting Conservatism in Debt Contracting
Evidence on the Role of Accounting Conservatism in Debt Contracting

Author: Elizabeth Francisca Gutierrez

Publisher:

Published: 2012

Total Pages: 59

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I examine how accounting conservatism relates to the design of private debt contracts with consideration of managerial risk preferences embedded in compensation contracts. Theoretical explanations for conservatism relate to the design of financial covenants or valuation of pledged assets in efficiently resolving asset substitution and incentive conflicts, respectively. I also consider conservatism in earnings in conjunction with other devices in signaling credit risk. I find evidence that accounting conservatism, the presence of financial covenants, and collateral are positively associated with the choice of long-term debt; with short-term debt constituting an alternative form of creditor protection. More notably, I find evidence of a predicted positive association between the use of collateral and conservatism. I fail to find a predicted positive association, however, between the presence of financial covenants and conservatism when managerial incentives indicate greater risk of asset substitution. Finally, I find no evidence of an association between conservatism in conjunction with earnings-based covenants and yield spreads as a measure of signaling content.

Debt Covenants and Accounting Conservatism
Debt Covenants and Accounting Conservatism

Author: Valeri V. Nikolaev

Publisher:

Published: 2010

Total Pages: 41

ISBN-13:

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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.