The Effect of Technical Default Cost on Discretionary Accounting Decisions

HassabElnaby, H., J. Mosebach, M. Mosebach, and S. Whisenant. The Effect of Technical Default Cost on Discretionary Accounting Decisions, 2014, International Research Journal of Applied Finance, V (8), 1075-1097.

Posted: 4 Feb 2005 Last revised: 3 Jun 2016

See all articles by Hassan R. Hassabelnaby

Hassan R. Hassabelnaby

Northern Kentucky University

Janet Mosebach

Boise State University

Michael Mosebach

University of Akron - The George W. Daverio School of Accountancy

Scott Whisenant

University of Kansas

Date Written: January 1, 2014

Abstract

In this study, we investigate whether the variation in the expected costs of technical default provides insights into whether managers manipulate earnings in periods prior to technical default as well as in the fiscal year in which avoidance of technical default is unlikely. We argue that managers have private information about the expected costs and consequences of default, and that, prior to default, managers condition their decisions about accounting choice and accounting (accrual) discretion on these expectations. We provide evidence on the endogeneity of two forms of discretion in accounting choices (i.e., choice of accounting methods and discretion in accounting accruals) in the context of testing the debt covenant hypothesis. Controlling for the endogeneity of the two forms or earnings management, we document that both forms of earnings management are associated with a lower cost of technical default and the use of either form of earnings management tends to reduce the use of the other. Our findings also suggest that earnings management is less likely when the expected cost of technical default is low, and that, managers appear to benefit from earnings management as such decisions are associated with a lower default cost for firms that enter technical default.

Keywords: Accounting choice, discretionary accounting, earnings management, accounting, debt, technical default, positive accounting

JEL Classification: G21, G30, G33, G39, M41, M43, M49

Suggested Citation

Hassabelnaby, Hassan R. and Mosebach, Janet and Mosebach, Michael and Whisenant, Scott, The Effect of Technical Default Cost on Discretionary Accounting Decisions (January 1, 2014). HassabElnaby, H., J. Mosebach, M. Mosebach, and S. Whisenant. The Effect of Technical Default Cost on Discretionary Accounting Decisions, 2014, International Research Journal of Applied Finance, V (8), 1075-1097., Available at SSRN: https://ssrn.com/abstract=660802 or http://dx.doi.org/10.2139/ssrn.660802

Hassan R. Hassabelnaby

Northern Kentucky University ( email )

Nunn Drive// BC 305D
Highland Heights, KY 41099
United States
859-572-7720 (Phone)

HOME PAGE: http://https://www.nku.edu/academics/cob.html?

Janet Mosebach

Boise State University ( email )

United States

Michael Mosebach

University of Akron - The George W. Daverio School of Accountancy ( email )

United States

Scott Whisenant (Contact Author)

University of Kansas ( email )

Capitol Federal Hall, #4101
1654 Naismith Dr.
Lawrence, KS 66045
United States
785-864-7577 (Phone)

HOME PAGE: http://https://business.ku.edu/scott-whisenant

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