The Real Effects of Accounting on Debt Repurchases
Posted: 10 Nov 2018
Date Written: June 2018
I investigate the real effects of accounting rules that permit the inclusion of gains and losses from debt repurchases in reported income. Because the gains or losses from repurchasing a company’s own debt securities are included on the firm’s income statement, managers have incentives to strategically time gain recognition. I predict that such strategic timing will be more likely to occur when the accounting rules (SFAS 145) allow the gain to be recognized in income before extraordinary items relative to when the gain is required to be recognized as an extraordinary item. Using a sample of 778 firms that repurchased debt between 1994 and 2011, I find evidence consistent with my predictions. Specifically, firms record larger extinguishment gains when earnings are (i) less than analysts’ forecasts, (ii) low relative to the prior year’s earnings, or (iii) less than zero. I find that these effects are stronger after the application of SFAS 145. This study contributes to the literature that examines real effects of accounting rules by providing evidence that firms repurchase their own debt at least in part for accounting benefits.
Keywords: Debt Repurchases
JEL Classification: M41, M48
Suggested Citation: Suggested Citation