Debt Contracts and the Need for Mandatory Accounting Changes
Hans Bonde Christensen
University of Chicago - Booth School of Business
Valeri V. Nikolaev
University of Chicago Booth School of Business
August 1, 2014
Chicago Booth Research Paper No. 13-66
We describe a mechanism through which accounting standard setters can facilitate the contracting process and improve economic resource allocation. Contracts cannot anticipate all future contingencies and, therefore, cannot specify optimal accounting treatments or necessary adjustments to GAAP in many eventualities. This contractual incompleteness opens the scope for opportunistic behavior in unanticipated states, which, being rationally anticipated at contract initiation, distorts the allocation of economic resources. Standard setters can alleviate the friction by acting as arbiters that complete GAAP ex post. We empirically test whether mandatory GAAP changes play an efficiency role by examining the revealed preferences for including vs. excluding mandatory GAAP changes in debt contracts. We find evidence consistent with standard setters playing such a role, but less so over time. Overall, the evidence suggests that there is an economic rationale for standard setting in debt markets, which implies that regulators with the objective of improving economic resource allocation cannot ignore debt contracting.
Number of Pages in PDF File: 37
Keywords: contracting efficiency, accounting regulation, GAAP changes
JEL Classification: M4, G32
Date posted: August 2, 2013 ; Last revised: August 9, 2014
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