Download this Paper Open PDF in Browser

Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment

56 Pages Posted: 16 Sep 2015 Last revised: 29 Sep 2017

Cyrus Aghamolla

University of Minnesota - Twin Cities

Nan Li

Columbia University - Columbia Business School

Date Written: September 28, 2017

Abstract

This study provides evidence that the use of conservative accounting in debt contracting depends on the enforceability of the contract. To test the effect of debt contract enforcement on borrowers' timely loss recognition, we exploit the staggered introduction of enhanced debt contract enforcement in Indian states as a natural experiment, where the implementation of the enforcement is exogenous to the accounting choices and borrowing behavior of firms. The main results reveal that enhanced enforcement has a significant positive effect on the timeliness of loss recognition of borrowing firms. We predict that the enhanced enforcement affects the financial reporting choices of borrowers through the increased emphasis on covenants and collateral. We find that the effect is strongest for firms who increased their overall borrowing and for firms with high levels of tangible assets, consistent with our hypothesized channels. This study also provides causal evidence that firms adopt conservative accounting due to lenders' demand.

Keywords: conservatism, debt contracts, enforcement

JEL Classification: M41

Suggested Citation

Aghamolla, Cyrus and Li, Nan, Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment (September 28, 2017). Columbia Business School Research Paper No. 15-84. Available at SSRN: https://ssrn.com/abstract=2661033 or http://dx.doi.org/10.2139/ssrn.2661033

Cyrus Aghamolla

University of Minnesota - Twin Cities ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Nan Li (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Paper statistics

Downloads
276
Rank
93,690
Abstract Views
1,668