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Financial Accounting Characteristics and Debt Covenants

45 Pages Posted: 9 Apr 2007  

Richard M. Frankel

Washington University in Saint Louis - Olin Business School

Lubomir P. Litov

University of Oklahoma - Michael F. Price College of Business; University of Pennsylvania - Wharton Financial Institutions Center

Date Written: April 2007

Abstract

We examine the relation between financial accounting characteristics and accounting-based debt covenants. We hypothesize that use of accounting-based covenants is more likely when asymmetric timeliness is higher and accounting discretion is reduced, because the covenants can more efficiently reduce agency costs in these circumstances. Overall, we find little association between the use of accounting-based debt covenants and three financial reporting characteristics (1) the magnitude of past discretionary accruals, (2) Basu's (1997) asymmetric timeliness measure, or (3) Ball and Shivakumar's (2006) asymmetric timeliness measure. We also are unable to find a consistently significant relation between these accounting characteristics and initial-covenant slack. Our results suggest that the relation between the effectiveness of accounting-based covenants and these characteristics is marginal.

Keywords: asymmetric timeliness, discretionary accruals, bond covenants

JEL Classification: M41, G32

Suggested Citation

Frankel, Richard M. and Litov, Lubomir P., Financial Accounting Characteristics and Debt Covenants (April 2007). Available at SSRN: https://ssrn.com/abstract=978711 or http://dx.doi.org/10.2139/ssrn.978711

Richard M. Frankel (Contact Author)

Washington University in Saint Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Lubomir P. Litov

University of Oklahoma - Michael F. Price College of Business ( email )

307 West Brooks
Norman, OK 73019-4004
United States

University of Pennsylvania - Wharton Financial Institutions Center

2306 Steinberg Hall-Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

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