The Importance of Accounting Changes in Debt Contracts: The Cost of Flexibility in Covenant Calculations

Posted: 11 Feb 2002

See all articles by Anne Beatty

Anne Beatty

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

K. Ramesh

Rice University

Joseph Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Abstract

In this paper we examine how the exclusion of voluntary and mandatory accounting changes from the calculation of covenant compliance affects the interest rate charged on the loan. After controlling for self-selection bias and other factors known to affect loan spreads, we find that the rate charged is 84 basis points lower when voluntary accounting changes are excluded and 71 basis points lower when mandatory accounting changes are excluded. Our results suggest that borrowers are willing to pay substantially higher interest rates to retain accounting flexibility that may help them avoid covenant violations and to avoid duplicate record keeping costs.

JEL Classification: G21, M41, G32

Suggested Citation

Beatty, Anne L. and Ramesh, K. and Weber, Joseph Peter, The Importance of Accounting Changes in Debt Contracts: The Cost of Flexibility in Covenant Calculations. Journal of Accounting & Economics, Vol. 33, No. 2, April 2002. Available at SSRN: https://ssrn.com/abstract=294247

Anne L. Beatty (Contact Author)

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

2100 Neil Avenue
Columbus, OH 43210
United States

K. Ramesh

Rice University ( email )

236 McNair Hall
Jones Graduate School of Business
Houston, TX 77005
United States
713.348.5380 (Phone)
713.348.6296 (Fax)

Joseph Peter Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States
617-253-4310 (Phone)

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