Financial Accounting Characteristics and Debt Covenants

Abstract:     
We examine the relation between financial accounting characteristics and accounting-based debt covenants. We hypothesize that use of accounting-based covenants is more likely when asymmetric timeliness is higher and accounting discretion is reduced, because the covenants can more efficiently reduce agency costs in these circumstances. Overall, we find little association between the use of accounting-based debt covenants and three financial reporting characteristics (1) the magnitude of past discretionary accruals, (2) Basu's (1997) asymmetric timeliness measure, or (3) Ball and Shivakumar's (2006) asymmetric timeliness measure. We also are unable to find a consistently significant relation between these accounting characteristics and initial-covenant slack. Our results suggest that the relation between the effectiveness of accounting-based covenants and these characteristics is marginal.

Keywords: asymmetric timeliness, discretionary accruals, bond covenants

JEL Classifications: M41, G32

Working Paper Series