Debt Financing and Accounting Conservatism in Private Firms

Posted: 7 Jan 2010 Last revised: 2 Dec 2014

See all articles by In-Mu Haw

In-Mu Haw

Texas Christian University - M.J. Neeley School of Business

Jay Junghun Lee

University of Massachusetts Boston

Woo-Jong Lee

Seoul National University

Date Written: June 29, 2013

Abstract

This study investigates the role of public debt financing in shaping accounting conservatism in privately held companies. We focus on the change in conservatism of private firms following initial issuance of public debt and examine the effects of agency conflicts between bondholders and shareholders on the change in conservatism. Regression analyses on a large sample of public bond issues by Korean private firms reveal the following. First, private firms with public debt exhibit a higher degree of conservatism than those with exclusively private debt. The incremental effect of public debt on the level of conservatism is virtually equivalent in magnitude to that of public equity. Second, and more importantly, private firms that issue public debt for the first time show a significant increase in conservatism, whereas corresponding public firms do not. Third, private firms with high agency costs of public debt (characterized by high information asymmetry and high credit risk) undergo a greater increase in conservatism following their initial bond issues than those with low agency costs. Further analysis shows that private firms sustain increased levels of conservatism even beyond the time period of average maturity of initial bonds, and that bond investors reward this long-term commitment to conservative accounting by gradually reducing interest rates for seasoned bond issuers. The findings of this study shed light on how information demand arising from public debt issuance, especially by private firms with high ex ante agency costs, engenders conservative financial reporting in emerging markets.

Keywords: private firms, debt financing, public bonds, accounting conservatism

JEL Classification: M41, G32, N25

Suggested Citation

Haw, In-Mu and Lee, Jay Junghun and Lee, Woo-Jong, Debt Financing and Accounting Conservatism in Private Firms (June 29, 2013). Contemporary Accounting Research, Vol. 31, No. 4, 2014, pp. 1220-1259. Available at SSRN: https://ssrn.com/abstract=1527052 or http://dx.doi.org/10.2139/ssrn.1527052

In-Mu Haw (Contact Author)

Texas Christian University - M.J. Neeley School of Business ( email )

Fort Worth, TX 76129
United States
817-921-7563 (Phone)
817-921-7227 (Fax)

Jay Junghun Lee

University of Massachusetts Boston ( email )

College of Management
100 Morrissey Blvd.
Boston, MA 02125
United States
(617)287-3181 (Phone)

Woo-Jong Lee

Seoul National University ( email )

Gwanak-ro 1, Gwanak-gu
Seoul, 151-916
Korea, Republic of (South Korea)

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