Accounting Standards and Debt Covenants: Has the ‘Balance Sheet Approach’ Led to a Decline in the Use of Balance Sheet Covenants?
Peter R. Demerjian
University of Washington - Michael G. Foster School of Business
July 21, 2011
Journal of Accounting & Economics (JAE), Vol. 52, Nos. 2-3, pp. 178-202, 2011
Recent years have seen a sharp decline in the use of balance sheet-based covenants in private debt contracts. I hypothesize that changes in accounting standards can explain part of this decline. Standard setting has shifted towards a “balance sheet approach”, which I predict has made the balance sheet less useful for contracting. I measure the effect of the balance sheet approach on specific borrowers using a volatility ratio. I find that borrowers with greater volatility ratios are less likely to have balance sheet-based covenants. This evidence is consistent with reductions in the contracting usefulness of the balance sheet being associated with reductions in balance sheet covenants.
Number of Pages in PDF File: 63
Keywords: Debt Contracting, Covenants, Balance Sheet, Accounting Standards, Fair Value
JEL Classification: M41
Date posted: August 4, 2011 ; Last revised: November 29, 2011
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