Legal Protection, Enforceability and Tests of the Debt Hypothesis: An International Study

Abstract

This study investigates whether differences in legal protection and law enforcement across countries affect the positive association between debt and discretionary accruals. Results using 11,127 firm observations from 48 countries for the years 1998 and 1999 show the following. First, high debt is associated with higher levels of discretionary accruals. Second, countries with poor legal protection and law enforcement are associated with high levels of discretionary accruals. Most interestingly, the positive association between debt and discretionary accruals, a proxy for earnings management, is weaker for countries with strong investor protection and law enforcement.

Keywords: legal protection, enforcement, debt, discretionary accruals

JEL Classification: M41, M43, M47