Debt Covenants and Accounting Conservatism

Journal of Accounting Research, Vol. 48, No. 1

41 Pages Posted: 21 Jan 2008 Last revised: 29 Aug 2010

Valeri V. Nikolaev

University of Chicago Booth School of Business

Date Written: March 2009

Abstract

Using a sample of over 5,000 debt issues, I test whether firms with more extensive use of covenants in their public debt contracts exhibit timelier recognition of economic losses in accounting earnings. Covenants govern the transfer of decision-making and control rights from shareholders to bondholders when a company approaches financial distress and thereby limit managers’ abilities to expropriate bondholder wealth. Covenants are expected to constrain managerial opportunism, however, only if the accounting system recognizes economic losses in earnings in a timely fashion. Thus, the demand for timely loss recognition should increase with a contract’s reliance on covenants. Consistent with this conjecture, I find evidence that reliance on covenants in public debt contracts is positively associated with the degree of timely loss recognition. I also find evidence that the presence of prior private debt mitigates this relationship.

Keywords: contracting demands, timely loss recognition, covenants, debt contracts

JEL Classification: M41, M24, G32

Suggested Citation

Nikolaev , Valeri V., Debt Covenants and Accounting Conservatism (March 2009). Journal of Accounting Research, Vol. 48, No. 1. Available at SSRN: https://ssrn.com/abstract=1085864

Valeri V. Nikolaev (Contact Author)

University of Chicago Booth School of Business ( email )

5807 South Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/valeri.nikolaev/index.html

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