Accounting Changes, Asset Substitution, and Debt Contracting
Accounting Changes, Asset Substitution, and Debt Contracting

Author: Masako N. Darrough

Publisher:

Published: 2019

Total Pages: 71

ISBN-13:

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This paper examines whether firms benefit, in debt contracting, from committing to incorporate future GAAP changes (referred to as rolling GAAP) or not to incorporate any future changes (referred to as frozen GAAP). We show that informative future accounting changes do not necessarily improve efficiency of debt contracts. We develop a parsimonious model to examine the interplay between a firm's investment decisions made ex ante and the accounting information revealed ex post the rule change. A firm borrows fund and makes investment decisions (project selection and effort choice) before a regulator may change accounting rules, which enable the creditor to observe an accounting signal about the project state. The firm rationally anticipates such a signal and tailors investment decisions accordingly. For example, if the firm knows that a bad project state is likely to be revealed, it will select a more risky technology and exacerbate asset substitution. In such a case, accounting changes might reduce the overall efficiency of debt contracting by distorting the firm's ex ante investment decisions. If asset substitution is sufficiently severe, accounting changes unambiguously reduce the firm's expected payoff and the efficiency of debt contracting, even though they might reduce information asymmetry between the lender and the borrower. Under such a scenario, a firm would prefer not to incorporate future accounting changes.

Accounting Changes and Debt Contracting
Accounting Changes and Debt Contracting

Author: Masako N. Darrough

Publisher:

Published: 2017

Total Pages: 0

ISBN-13:

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This paper examines whether firms benefit, in debt contracting, from committing to incorporate future GAAP changes (referred to as rolling GAAP) or not to incorporate any future changes (referred to as frozen GAAP). We show that informative future accounting changes do not necessarily improve the efficiency in debt contracts. We develop a parsimonious model to examine the interplay between the firm's investment decision made ex ante and the accounting information revealed ex post the rule change. These accounting changes enable the creditor to observe an accounting signal about the project state. Firms rationally anticipate such a signal and tailor investment decisions accordingly. If asset substitution is sufficiently severe, accounting changes unambiguously reduce the firm's expected payoff and the efficiency of debt contracting, even though they might reduce information asymmetry between the lender and the borrower. Under such a scenario, a firm would prefer not to incorporate future accounting changes.

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

ISBN-13:

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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.

Three Essays on Leverage and Debt Contracts
Three Essays on Leverage and Debt Contracts

Author: Hugh Marble

Publisher:

Published: 2007

Total Pages:

ISBN-13:

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ABSTRACT: My studies considered three things: (1) the choice between non-recourse secured debt and recourse debt (unsecured debt or secured debt with recourse) by firms that are sequentially acquiring assets and then making investment choices once those assets have been acquired, (2) how secured debt financing impacts both the asset substitution and underinvestment problems, and (3) the frequency with which credit rating changes result from changes in the firm's operating environment versus changes in capital structure controlled by management. First, non-recourse secured debt is shown to be optimal for firms engaged in the acquisition of assets which have little need for non-contractible ongoing investment. Unsecured debt provides superior post-acquisition incentives for owners of assets that require ongoing investment or that can be easily modified. Empirical tests using Real Estate Investment Trusts provide evidence supporting the model and consistent with previous work. Second, the underinvestment problem does not depend on the proportion of the original debt that is secured and the asset substitution problem decreases in the proportion of the original debt that is secured. Debt capacity increases with the proportion of debt that is secured as the asset substitution problem is lower for a given level of debt. An analysis of a large sample of firms with COMPUSTAT data supports the model predictions. Third, I found that management action plays a significant role in credit rating changes. Twenty-four percent of downgrades and 41% of upgrades have a substantial management influence. The frequency of management impact on credit ratings shows the limitations of credit risk modeling using structural models that assume constant capital structure.

CEO Turnover, Information Uncertainty, and Debt Contracting
CEO Turnover, Information Uncertainty, and Debt Contracting

Author: Saiying Deng

Publisher:

Published: 2018

Total Pages: 54

ISBN-13:

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CEO turnovers are important corporate events that can lead to significant changes within the firm. We find that CEO departures are associated with a subsequent increase in bank loan financing. The negative effect that CEO departures have on borrowing costs is largely driven by forced CEO turnovers. Following such departures, firms pay higher loan spreads, see an increase in covenants, and are more likely to be subject to collateral requirements, when compared to matched non-turnover and voluntary turnover firms. Evidence suggests that asset substitution and changes in accounting information quality helps to explain the observed worsened terms following forced dismissals. On the other hand, more traditional voluntary departures are unrelated to changes in price and non-price loan terms.

Three Essays in Accounting Regulation and Debt Contract Characteristics
Three Essays in Accounting Regulation and Debt Contract Characteristics

Author: Bryan S. Graden

Publisher:

Published: 2015

Total Pages: 112

ISBN-13:

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This dissertation is comprised of three essays relating to accounting regulation and debt contracting. The first essay is designed to draw inferences about lenders' demand for lease accounting rules in light of proposed lease accounting standard changes. I study changes in lease-related debt covenants surrounding the adoption of Statement of Financial Accounting Standards 13: Accounting for Leases in 1976. I find that lenders are significantly less likely to inhibit leasing activity via lease restrictions after SFAS 13 adoption and that lenders are significantly more likely to modify debt covenants to capitalize operating leases across time in the post-SFAS 13-adoption period. The findings suggest that lenders adapt debt covenant definitions to changes in accounting standards. Further, the findings indicate that lenders adapt debt covenant definitions to changes in borrowers' financial reporting incentives. The second essay investigates whether lenders capitalize operating leases uniformly when defining debt covenants. I argue that bankruptcy treatment of leases affects lenders' incentives to incorporate operating leases into debt covenants leading to differential treatment of operating leases as opposed to a "one-size-fits-all" contracting treatment of operating leases. Using a hand-collected sample of lending agreements from firms that use operating leases extensively, I find a positive association between the probability of lenders capitalizing operating leases into debt covenants and the duration of borrowers' lease contracts. The results indicate that lenders discriminate among operating leases when designing debt covenants and suggest that operating leases vary in their effect on credit risk. The third essay examines the relation between contract-specified accounting standards and private lender country of domicile. Prior studies provide evidence suggesting that equity investors' information gathering and processing costs are related to differences in reported accounting standards. While lenders have access to private information about prospective borrowers, I document that US lenders are more likely to contract on US accounting standards that match their home country. These findings generalize to Canadian, UK, and IFRS-country lenders and suggest that lenders exhibit a preference for home-country GAAP. In additional tests, I examine whether the degree of difference between borrower- and lender-country accounting standards affects the likelihood that a debt contract from a US lender specifies US GAAP and whether contracting on similar GAAP affects other loan terms. I find no significant effect on the probability of contracting on US GAAP when accounting differences are larger. Similarly, I find no significant evidence that lenders modify loan spread, maturity, and financial covenant use for loans from US lenders that specify US accounting standards.

The Importance of Accounting Changes in Debt Contracts
The Importance of Accounting Changes in Debt Contracts

Author: Anne Beatty

Publisher:

Published: 2002

Total Pages:

ISBN-13:

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In this paper we examine how the exclusion of voluntary and mandatory accounting changes from the calculation of covenant compliance affects the interest rate charged on the loan. After controlling for self-selection bias and other factors known to affect loan spreads, we find that the rate charged is 84 basis points lower when voluntary accounting changes are excluded and 71 basis points lower when mandatory accounting changes are excluded. Our results suggest that borrowers are willing to pay substantially higher interest rates to retain accounting flexibility that may help them avoid covenant violations and to avoid duplicate record keeping costs.

Accounting and Debt Markets
Accounting and Debt Markets

Author: Mark Clatworthy

Publisher: Taylor & Francis

Published: 2021-05-13

Total Pages: 150

ISBN-13: 1000344606

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Accounting and Debt Markets: Four Pieces on the Role of Accounting Information in Debt Markets provides novel and up-to-date evidence on the role of accounting information in debt markets Companies and organisations worldwide rely heavily on debt markets for short, medium and long-term financing, and debt markets and financial intermediaries have significant effects on the real economy. Accounting information has various functions in debt markets, including inter alia, informing pricing decisions and credit ratings, determining the allocation of creditor control rights and establishing bank capital adequacy requirements. The chapters in this book provide illustrative discussion, analysis and evidence on the importance of accounting information in credit markets. The first of the four pieces reflects on how a conservative financial reporting system helps firms obtain debt funds and with better conditions, and why this is the case. The second examines the effects of accounting disclosure on credit ratings of private companies and shows that accounting information is useful for credit rating agencies. The two final pieces reflect on how banks should account for credit losses, and on how regulators are tackling this issue. The chapters in this book were originally published as a special issue of Accounting and Business Research.

Evaluation of Econometric Models
Evaluation of Econometric Models

Author: Jan Kmenta

Publisher: Academic Press

Published: 2014-05-10

Total Pages: 425

ISBN-13: 1483267342

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Evaluation of Econometric Models presents approaches to assessing and enhancing the progress of applied economic research. This book discusses the problems and issues in evaluating econometric models, use of exploratory methods in economic analysis, and model construction and evaluation when theoretical knowledge is scarce. The data analysis by partial least squares, prediction analysis of economic models, and aggregation and disaggregation of nonlinear equations are also elaborated. This text likewise covers the comparison of econometric models by optimal control techniques, role of time series analysis in econometric model evaluation, and hypothesis testing in spectral regression. Other topics include the relevance of laboratory experiments to testing resource allocation theory and token economy and animal models for the experimental analysis of economic behavior. This publication is intended for students and researchers interested in evaluating econometric models.