The Impact of Financial Reporting Quality on Debt Contracting: Evidence from Internal Control Weakness Reports

52 Pages Posted: 18 Aug 2009 Last revised: 7 Sep 2010

See all articles by Anna M. Costello

Anna M. Costello

University of Michigan, Stephen M. Ross School of Business

Regina Wittenberg Moerman

University of Southern California

Date Written: September 4, 2010

Abstract

We examine the effect of financial reporting quality on the trade-off between monitoring mechanisms used by lenders. We rely on Sarbanes-Oxley internal control reports to measure financial reporting quality. We find that when a firm experiences a material internal control weakness, lenders decrease their use of financial covenants and financial-ratio-based performance pricing provisions and substitute them with alternatives such as price and security protections and credit-rating-based performance pricing provisions. We also find that changes in debt contract design following internal control weaknesses are substantially different from those following restatements, where lenders impose tighter monitoring on managers’ actions, but do not decrease their use of financial statement numbers.

Keywords: financial reporting quality, debt contracting, internal control reports, a material internal control weakness, the syndicated loan market

JEL Classification: M41

Suggested Citation

Costello, Anna M. and Wittenberg Moerman, Regina, The Impact of Financial Reporting Quality on Debt Contracting: Evidence from Internal Control Weakness Reports (September 4, 2010). Journal of Accounting Research, forthcoming. , Available at SSRN: https://ssrn.com/abstract=1455985 or http://dx.doi.org/10.2139/ssrn.1455985

Anna M. Costello

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Regina Wittenberg Moerman (Contact Author)

University of Southern California ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

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