Creditor Control Rights and Financial Reporting Conservatism

54 Pages Posted: 11 Apr 2012

See all articles by Cong Wang

Cong Wang

The Chinese University of Hong Kong, Shenzhen

Fei Xie

University of Delaware - Lerner College of Business and Economics; European Corporate Governance Institute (ECGI)

Xiangang Xin

City University of Hong Kong

Date Written: May 1, 2011

Abstract

Covenant violations transfer control rights from shareholders/managers to creditors and provide a clear mechanism through which creditors can impose their preference on corporate financial reporting policies. Consistent with creditors using their control rights to demand more conservative financial reporting, we find significant evidence that firms exhibit a higher level of accounting conservatism after covenant violations. Results from quasi-discontinuity regressions show that the effect of covenant violations on accounting conservatism is beyond that of deteriorating firm performance that triggers covenant violations. In addition, the post-violation increase in accounting conservatism is more pronounced in firms with higher expected agency costs of debt and firms experiencing more severe violations, and is more evident in the years immediately following covenant violations. Our findings provide direct support for debtholder demand for accounting conservatism (Watts (2003)) and highlight the importance of creditor control rights and shareholder-debtholder conflicts in shaping corporate financial reporting policies.

Suggested Citation

Wang, Cong and Xie, Fei and Xin, Xiangang, Creditor Control Rights and Financial Reporting Conservatism (May 1, 2011). Available at SSRN: https://ssrn.com/abstract=2038363 or http://dx.doi.org/10.2139/ssrn.2038363

Cong Wang

The Chinese University of Hong Kong, Shenzhen ( email )

Fei Xie (Contact Author)

University of Delaware - Lerner College of Business and Economics ( email )

42 Amstel Ave
Newark, DE 19716
United States
(302) 8313811 (Phone)

HOME PAGE: http://sites.google.com/site/feisresearch/

European Corporate Governance Institute (ECGI) ( email )

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1000 Brussels
Belgium

Xiangang Xin

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
Hong Kong

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