Nonrecurring Items in Debt Contracts

41 Pages Posted: 19 Apr 2015 Last revised: 22 Nov 2017

See all articles by Anne Beatty

Anne Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Lin Cheng

The University of Arizona - Eller College of Management

Tzachi Zach

Ohio State University (OSU) - Fisher College of Business

Date Written: November 19, 2017

Abstract

Using a large sample of debt contracts, we study the determinants of excluding nonrecurring items from covenant calculations. We investigate this choice across firms, across items, and through time. We find that nonrecurring items are more likely to be excluded when the agency costs of debt are higher and less likely to be excluded when they predict borrowers’ performance. Our evidence further suggests that the interplay between agency costs and nonrecurring items’ predictive ability affects the decision to exclude these items from covenant computations. Finally, when examining the exclusion by different nonrecurring item types, we find confirmatory evidence that the probability of exclusion decreases with the predictive ability for borrowers’ future performance of major nonrecurring item types. Overall, our research extends the literature on the determinants of contract design and improves understanding of the usefulness of accounting information in debt contracting.

Keywords: Nonrecurring items; debt contracting; financial covenants; agency costs; covenant slack

JEL Classification: G10, G32, M41

Suggested Citation

Beatty, Anne L. and Cheng, Lin and Zach, Tzachi, Nonrecurring Items in Debt Contracts (November 19, 2017). Contemporary Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2595800 or http://dx.doi.org/10.2139/ssrn.2595800

Anne L. Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

Lin Cheng (Contact Author)

The University of Arizona - Eller College of Management ( email )

McClelland Hall, Room 301Q
1130 E. Helen Street
Tucson, AZ 85721
United States

Tzachi Zach

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-4101 (Phone)

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