Accounting Conservatism and Managerial Information Acquisition

37 Pages Posted: 30 Jul 2020 Last revised: 29 Sep 2021

See all articles by Christian Laux

Christian Laux

Vienna University of Economics and Business; Vienna Graduate School of Finance (VGSF); European Corporate Governance Institute (ECGI)

Volker Laux

University of Texas at Austin - McCombs School of Business

Date Written: September 28, 2021

Abstract

Empirical studies find that conservative reporting generally plays a positive role in debt contracting. A key benefit of conservatism is that it results in more frequent early warning signals that allow lenders to intervene and take corrective actions. However, theoretical contributions point out that conservatism also involves costs as it increases the risk of false alarms that lead to excessive lender intervention. We show that managers' incentive and ability to gather information can alleviate the concern for false alarms. The reason is that, following a covenant violation, managers have an incentive to search for additional information, hoping to find evidence that persuades lenders not to intervene and to waive the covenant. The manager's information acquisition reduces the risk that lenders act on false alarms and hence the downside of conservative reporting. Our model also provides a novel explanation for the empirical observation that covenant violations often trigger debt contract renegotiations and covenant waivers.

Keywords: accounting conservatism, debt contracting, early warning, managerial information acquisition

Suggested Citation

Laux, Christian and Laux, Volker, Accounting Conservatism and Managerial Information Acquisition (September 28, 2021). Available at SSRN: https://ssrn.com/abstract=3642806 or http://dx.doi.org/10.2139/ssrn.3642806

Christian Laux

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Volker Laux (Contact Author)

University of Texas at Austin - McCombs School of Business ( email )

2317 Speedway
Austin, TX 78712
United States

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