Balance Sheet Conservatism and Debt Contracting

51 Pages Posted: 14 Sep 2008 Last revised: 26 Nov 2016

See all articles by Jayanthi Sunder

Jayanthi Sunder

University of Arizona - Eller College of Management

Shyam V. Sunder

University of Arizona - Department of Accounting

Jingjing Zhang

McGill University - Desautels Faculty of Management

Date Written: September 24, 2016

Abstract

We study the role of borrowers’ balance sheet conservatism (i.e., conservatism in asset values) in debt contract design. We find that borrowing costs are decreasing in the degree of balance sheet conservatism, and this effect is stronger for firms with lower credit quality. This is consistent with balance sheet conservatism reducing lenders’ uncertainty about the liquidation value of assets, thus facilitating the ex ante screening of borrowers. We predict that better ex ante screening also reduces the need for ex post monitoring, and find that balance sheet conservatism is associated with less restrictive covenant terms. Further, we find that asymmetric timeliness in earnings is associated with lower borrowing costs only when balance sheet conservatism is not high. This result suggests that lenders appear to recognize the constraining effect of high balance sheet conservatism on future conservatism in earnings.

Keywords: Conservatism, balance sheet, debt contracting, accounting constraints

JEL Classification: G32, M41

Suggested Citation

Sunder, Jayanthi and Sunder, Shyam and Zhang, Jingjing, Balance Sheet Conservatism and Debt Contracting (September 24, 2016). Available at SSRN: https://ssrn.com/abstract=1267504 or http://dx.doi.org/10.2139/ssrn.1267504

Jayanthi Sunder (Contact Author)

University of Arizona - Eller College of Management ( email )

School of Accountancy
1130 E Helen St.
Tucson, AZ 85721
United States
520-626-8489 (Phone)

Shyam Sunder

University of Arizona - Department of Accounting ( email )

210 L McClelland Hall
1130 E Helen St
Tucson, AZ 85721
United States

Jingjing Zhang

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5
Canada

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