Creditor Control Rights, State of Nature Verification, and Financial Reporting Conservatism

58 Pages Posted: 5 Aug 2011 Last revised: 6 Aug 2012

Liang Tan

George Washington University - Department of Accountancy

Date Written: June 1, 2010

Abstract

I examine the impact of state-contingent allocation of creditor control rights on financial reporting. Using a discontinuity analysis, I find that firms’ financial reporting becomes more conservative immediately after covenant violations and this effect persists for at least eight quarters. The conservatism effect is more pronounced when creditors possess greater bargaining power, when firms’ operations are more volatile, and when creditors put Chief Restructuring Officers in place. My findings identify a specific channel through which debt financing shapes corporate financial reporting and provide direct evidence supporting the debt contracting explanation for conservatism posited in Watts (2003).

Keywords: Accounting Conservatism, Covenant Violation, Debt Contracting, Control Rights

JEL Classification: D83, G32, M41

Suggested Citation

Tan, Liang, Creditor Control Rights, State of Nature Verification, and Financial Reporting Conservatism (June 1, 2010). Journal of Accounting & Economics (JAE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1905701 or http://dx.doi.org/10.2139/ssrn.1905701

Liang Tan (Contact Author)

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
Washington, DC 20052
United States

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