Accounting Quality and Debt Contracting

45 Pages Posted: 17 Sep 2004

See all articles by Sreedhar T. Bharath

Sreedhar T. Bharath

Arizona State University (ASU) - Finance Department

Jayanthi Sunder

University of Arizona - Eller College of Management

Shyam V. Sunder

University of Arizona - Department of Accounting

Date Written: December 2006

Abstract

We study the role of borrower accounting quality in debt contracting. Specifically, we examine how accounting quality affects the borrower's choice of private versus public debt market and how the design of debt contracts vary with accounting quality in the two markets. We find that accounting quality affects the choice of the market, with poorer accounting quality borrowers preferring private debt (bank loans). This is consistent with banks possessing superior information access and processing abilities which reduce adverse selection costs for borrowers. We also find that accounting quality has an economically significant but differential impact on contract design in the two markets consistent with differences in recontracting flexibility across the two markets. For private debt (which has greater recontracting flexibility), both the price (interest) and non-price (maturity and collateral) terms are significantly more stringent for poorer accounting quality borrowers, unlike public debt where only the price terms are more stringent. The impact of accounting quality on interest spreads of public debt is 2.5 times that of the private debt, since the price terms alone reflect the variation in accounting quality. Overall, the results are consistent with greater recontracting flexibility of banks enabling them to write more customized contracts relative to dispersed bondholders.

Keywords: Accounting Quality, Accruals, Loans, Bonds, Spreads, Maturity, Collateral

JEL Classification: G32, G21, M4, G31

Suggested Citation

Bharath, Sreedhar T. and Sunder, Jayanthi and Sunder, Shyam, Accounting Quality and Debt Contracting (December 2006). Available at SSRN: https://ssrn.com/abstract=591342 or http://dx.doi.org/10.2139/ssrn.591342

Sreedhar T. Bharath (Contact Author)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

Jayanthi Sunder

University of Arizona - Eller College of Management ( email )

School of Accountancy
1130 E Helen St.
Tucson, AZ 85721
United States
520-626-8489 (Phone)

Shyam Sunder

University of Arizona - Department of Accounting ( email )

210 L McClelland Hall
1130 E Helen St
Tucson, AZ 85721
United States

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