The Effects of Debt Contracting on Voluntary Accounting Method Changes

Posted: 4 Nov 2002

See all articles by Anne Beatty

Anne Beatty

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

Joseph Weber

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

Abstract

This study examines whether the provisions of a firm's bank debt contracts affect its accounting choices. Starting with a sample of firms who have bank debt and who also voluntarily changed accounting methods, we investigate whether the likelihood that the change increased (rather than decreased) the borrowers income depends on (1) whether the changes in accounting methods affect the bank debt contract calculations, (2) the expected costs of violating the bank debt covenants, (3) whether performance pricing provisions affect the interest rate on the loan, and (4) whether the bank debt contract contains accounting-based dividend restrictions. After controlling for other motives for changing accounting methods, we find that borrowers whose bank debt contracts allow accounting method changes to affect contact calculations are more likely to make income-increasing rather than income-decreasing changes. This increase in likelihood of an income-increasing change is attenuated when expected costs of technical violation are lower because there is a single lender, and occurs for borrowers whose debt contacts have performance pricing and dividend restrictions. These results suggest that incentives to lower interest rates through performance pricing or to retain dividend payment flexibility influence borrowers' accounting method choices, thereby addressing the fundamental questions posed by Fields et al. (2001) of whether, under what circumstances, and how accounting choice matters.

Keywords: Accounting Choice, Debt Contracting, Debt Covenants, Performance Pricing, Dividend Restrictions

JEL Classification: M41, G20, G21, G32, G35

Suggested Citation

Beatty, Anne L. and Weber, Joseph Peter, The Effects of Debt Contracting on Voluntary Accounting Method Changes. Accounting Review, January 2003. Available at SSRN: https://ssrn.com/abstract=331761

Anne L. Beatty (Contact Author)

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

2100 Neil Avenue
Columbus, OH 43210
United States

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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