Corporate Debt Financing and Earnings Quality

22 Pages Posted: 13 Jul 2010

See all articles by Aloke (Al) Ghosh

Aloke (Al) Ghosh

affiliation not provided to SSRN

Doocheol Moon

SUNY at Old Westbury - School of Business

Date Written: 2009-12

Abstract

Our study establishes linkages between two extensively researched areas, debt financing and the quality of earnings. Debt can have a ‘positive influence’on earnings quality because managers are likely to use their accounting discretion to provide private information about the firms’ future prospects to lower financing costs. For high debt, it can also have a ‘negative influence’ on earnings quality as managers use accruals aggressively to manage earnings to avoid covenant violations. Using accruals quality as a proxy for earnings quality, we document a non-monotonic (curvilinear) relation between debt and earnings quality. The relationship is positive at low levels of debt and negative at high debt levels with an inflection point around 41%. Our results suggest that firms that rely heavily on debt financing might be willing to bear higher costs of borrowing from lower earnings quality because the benefits from avoiding potential debt covenant violations exceed the higher borrowing costs.

Suggested Citation

Ghosh, Aloke (Al) and Moon, Doocheol, Corporate Debt Financing and Earnings Quality (2009-12). Journal of Business Finance & Accounting, Vol. 37, Issue 5-6, pp. 538-559, June/July 2010, Available at SSRN: https://ssrn.com/abstract=1639219 or http://dx.doi.org/10.1111/j.1468-5957.2010.02194.x

Aloke (Al) Ghosh (Contact Author)

affiliation not provided to SSRN

No Address Available

Doocheol Moon

SUNY at Old Westbury - School of Business ( email )

Old Westbury, NY 11568-0210
United States

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