Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment

Posted: 23 May 2019

See all articles by Cyrus Aghamolla

Cyrus Aghamolla

University of Minnesota - Twin Cities

Nan Li

University of Minnesota - Twin Cities - Carlson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2018

Abstract

This study provides evidence that the use of conservative accounting in debt contracting depends on the enforceability of the contract. To test the effect of debt contract enforcement on borrowers' timely loss recognition, we exploit the staggered introduction of enhanced debt contract enforcement in Indian states as a natural experiment, where the implementation of the enforcement is exogenous to the accounting choices and borrowing behavior of firms. The main results show that enhanced enforcement has a significant positive effect on the timeliness of loss recognition of borrowing firms. We find that the effect is strongest for firms that increased their overall borrowing and for firms with high levels of tangible assets, consistent with a collateral‐based explanation. This study also provides causal evidence that firms adopt conservative accounting due to lenders' demand.

Keywords: debt contracts; enforcement; timely loss recognition; conservatism

JEL Classification: G33; K12; M41

Suggested Citation

Aghamolla, Cyrus and Li, Nan, Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment (December 1, 2018). Journal of Accounting Research, Vol. 56, No. 5, 2019. Available at SSRN: https://ssrn.com/abstract=3378124

Cyrus Aghamolla

University of Minnesota - Twin Cities ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Nan Li (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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