Choice of Accounting Practices in Brazil: An Analysis from the Contractual Covenants Hypothesis Perspective

Abstract

This paper aims to investigate whether managers of Brazilian companies registered at the Securities and Exchange Commission (CVM) which have made long-term financial borrowings (bonds and bank loans), voluntarily have changed their accounting practices in order to prevent the violation of their covenants (based on accounting numbers) specified in their lending agreements. During the analysis of this phenomenon, previous studies suggest that company managers have adopted less conservative accounting practices (increasing their earnings and equity) in order to avoid violation of financial covenants. It was possible to demonstrate by the analysis of 125 Brazilian companies (registered at the CVM), with records of long-term borrowings in the credit market via bonds and bank loans (from 2000 to 2006), and using univariate (empirical histograms and chi–square tests) and multivariate (logistic regression) statistical tests, that these companies did not fulfill voluntarily changes in accounting practices in order to avoid violation of financial covenants. Two relevant items can explain the observed results: the low costs in cases of violation of financial covenants, and the active accounting regulations and monitoring efforts of regulatory agencies for public services, especially in the electricity sector. The main contribution of the observed results is to demonstrate that, despite the existence of financial covenants in debt securities issued by the Brazilian companies analyzed, there is no significant evidence of opportunistic changes in accounting practices to avoid breaches in financial covenants.

Keywords: financial accounting, positive theory of accounting, covenants

JEL Classification: M41, M44