Conservatism in Debt Contracting: Theory and Empirical Evidence

Abstract

This paper surveys both the theoretical and the empirical archival literature on conservatism when accounting information is used for debt contracting. The theoretical literature shows mixed results whether conservative accounting is desirable, which depends on the underlying agency problem, the information available, and the contracting space. The empirical literature takes a more holistic view in measuring the degree of conservatism. It studies a broad array of possible effects of conservatism in debt financing, but also beyond. The results overwhelmingly support the view that conservatism plays a useful role in debt contracting, although there are also some mixed results. We describe key results and empirical designs, and we provide suggestions for future research.

Keywords: accounting conservatism; debt contracting

JEL Classification: M40; M41; G30; G31