Mandatory IFRS Adoption, Fair Value Accounting and Accounting Information in Debt Contracts
University of Chicago
Temple University - Fox School of Business and Management ; Temple University - Department of Accounting
London Business School
September 11, 2013
A significant fall in accounting-based debt covenants and increase in non-accounting covenants follows mandatory IFRS adoption. Covenant substitution increases in the difference between prior domestic GAAP and IFRS. No such effects are observed in a non-adopting country control group. We attribute these results primarily to the IASB’s fair-value orientation. We argue that fair valuing adds transitory shocks to earnings that make it an inferior variable in the context of long term debt agreements (Li, 2010), and that would be excluded from the covenant definition of earnings if it was not costly or impossible to do so. Fair values also are subjective and hence easier to manipulate. An option to fair value a firm’s own liabilities reduces the effectiveness of leverage covenants, in which lenders seek to compare the firm’s assets with the amount they are owed, which is the historical face value of the debt (not its fair value). Overall, we hypothesize that IFRS appear to sacrifice debt contracting usefulness in favor of other objectives such as complying with an abstract accounting measurement model and incorporating contemporary information in the financial statements. IFRS fair value standards appear to be based on a supply-driven model of accounting that does not take demand characteristics into consideration.
Number of Pages in PDF File: 84
Keywords: IFRS, Fair value, Debt covenants, Contracting, Accounting
JEL Classification: F34, G15, K22, M41working papers series
Date posted: June 15, 2013 ; Last revised: April 21, 2014
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