Earnings Management Around Debt-Covenant Violations: An Empirical Investigation Using a Large Sample of Quarterly Data

54 Pages Posted: 26 Aug 2013

See all articles by Anand Jha

Anand Jha

Texas A&M International University; Wayne State University

Date Written: August 25, 2013

Abstract

I find that managers manage earnings upward in the quarters preceding a debt-covenant violation, but downward in the quarter a violation occurs. And they continue to manage earnings downward while the firm remains in violation. Because this scenario can play out within a year, the use of yearly data to examine the debt-covenant hypothesis can be problematic. Further analysis shows that the earnings management around the debt-covenant violation is also done to improve the manager’s bargaining power in the renegotiation that follows the violation. Further, I find no evidence of excessive earnings management by high-debt firms to stave off a violation, but I do find evidence that the Sarbanes Oxley Act restrains managers from using accruals to stave off a violation. These results are based on examining 193,803 firm-quarters, 8,804 firms, and 2,035 new covenant violations spanning 1996 to 2007.

Keywords: debt covenants, debt-covenant hypothesis, earnings management, discretionary accruals, bargaining

JEL Classification: G20, G21, M40, M41

Suggested Citation

Jha, Anand and Jha, Anand, Earnings Management Around Debt-Covenant Violations: An Empirical Investigation Using a Large Sample of Quarterly Data (August 25, 2013). Journal of Accounting, Auditing and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2315764

Anand Jha (Contact Author)

Wayne State University ( email )

5201 Cass Avenue
Detroit, MI 48202

HOME PAGE: http://https://ilitchbusiness.wayne.edu/faculty/profile.php?id=142206

Texas A&M International University ( email )

Laredo, TX 78041
United States
9563262581 (Phone)

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