The Relation between Incentives to Avoid Debt Covenant Default and Insider Trading

44 Pages Posted: 30 Apr 2001

See all articles by Messod D. Beneish

Messod D. Beneish

Indiana University - Kelley School of Business - Department of Accounting

Eric Press

Temple University - Department of Accounting

Mark E. Vargus

University of Texas at Dallas - Department of Accounting & Information Management

Date Written: April 23, 2001

Abstract

We use a sample of firms that experience technical default to investigate whether an observable managerial action, managers? trading, is useful in (1) determining the existence of pre-default earnings management, and (2) in assessing whether specific contract modifications in renegotiated debt agreements are costly. We find income-increasing accruals and unexpected accruals in the year preceding the year of default of magnitudes sufficient to forestall default. We show, however, that the significant income-increasing accruals and unexpected accruals occur only in firms in which managers engage in abnormal insider selling. Our evidence suggests that by managing earnings to delay the onset of default, managers sell their equity-contingent wealth at higher prices. Finally, our evidence implies that renegotiated debt provisions?such as additional covenants and restricted borrowing?are costly for firms with greater investment opportunities prior to default.

JEL Classification: M41, M43, G21, G33

Suggested Citation

Beneish, Messod Daniel and Press, Eric G. and Vargus, Mark E., The Relation between Incentives to Avoid Debt Covenant Default and Insider Trading (April 23, 2001). Available at SSRN: https://ssrn.com/abstract=268548 or http://dx.doi.org/10.2139/ssrn.268548

Messod Daniel Beneish (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2628 (Phone)
812-855-4985 (Fax)

Eric G. Press

Temple University - Department of Accounting ( email )

Philadelphia, PA 19122
United States
215-204-8127 (Phone)
215-204-5587 (Fax)

HOME PAGE: http://oll.temple.edu/epress/

Mark E. Vargus

University of Texas at Dallas - Department of Accounting & Information Management ( email )

2601 North Floyd Road
Richardson, TX 75083-0688
United States
972-883-4772 (Phone)

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