GAAP Goodwill and Debt Contracting Efficiency: Evidence from Net-Worth Covenants
Richard M. Frankel
Washington University in Saint Louis - Olin Business School
Mellon Capital Management
Ohio State University (OSU) - Fisher College of Business
Review of Accounting Studies, Vol. 13, No. 1, 2007
We study the role of goodwill in promoting contracting efficiency and the effect of SFAS 141 and 142 on this role. We provide three main results. First, when a lending agreement contains some type of minimum-net-worth covenant, the probability of a tangible-net-worth covenant is decreasing in the borrower's goodwill. Second, the use of tangible-net-worth covenants has increased since the promulgation of SFAS 141 and 142. Finally, covenant slack is not significantly related to the use of tangible-net-worth covenants relative to net-worth covenants. These results suggest that contracting parties realize efficiency gains by permitting borrowers' actions to be restricted by the value of GAAP goodwill. However, the salutary effects of goodwill on contracting efficiency have been reduced due to recent changes in GAAP.
Keywords: Debt Covenants, Goodwill, Financial Accounting
JEL Classification: M41, M44, L14, G32Accepted Paper Series
Date posted: October 26, 2007
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