Creditor Protection and Accrual Quality: The Effect of State Laws

40 Pages Posted: 7 Jul 2007

See all articles by Mei Cheng

Mei Cheng

University of Arizona - Department of Accounting

Sattar Mansi

Virginia Polytechnic Institute & State University

John K. Wald

University of Texas at San Antonio

Date Written: August 29, 2007

Abstract

State laws vary with respect to protecting a corporation's creditors vis-a-vis its shareholders. In particular, states vary in their limits on payouts which potentially transfer wealth from creditors to shareholders. We hypothesize that states with tighter constraints on payouts generally decrease the opportunity for earnings management leading to better accrual quality. Based on a large sample of corporations covering the period from 1987 to 2004, we find evidence consistent with this hypothesis. We also extend the debt covenant hypothesis to state payout restrictions and find cross-sectional variation within states with tighter constraints. Our findings show that accrual quality suffers as firms approach their payout constraint. Overall, the results suggest that stronger creditor protection laws have an impact on firm financial reporting quality.

Keywords: State laws, Payout restrictions, Accrual quality, Debt-covenant hypothesis

JEL Classification: K22, M41

Suggested Citation

Cheng, Mei and Mansi, Sattar and Wald, John K., Creditor Protection and Accrual Quality: The Effect of State Laws (August 29, 2007). AAA 2008 Financial Accounting and Reporting Section (FARS) Paper. Available at SSRN: https://ssrn.com/abstract=998523 or http://dx.doi.org/10.2139/ssrn.998523

Mei Cheng

University of Arizona - Department of Accounting ( email )

Tucson, AZ 85721
United States

Sattar Mansi

Virginia Polytechnic Institute & State University ( email )

John K. Wald (Contact Author)

University of Texas at San Antonio ( email )

1 UTSA Circle
San Antonio, TX 78249
United States
210-458-6324 (Phone)

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