2017
DOI: 10.1111/1911-3846.12303
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Further Evidence on Consequences of Debt Covenant Violations

Abstract: We present new evidence on debt covenant violation (DCV) consequences that have not previously been examined in the literature. In particular, we show that a DCV triggers significant information asymmetry and uncertainty on the part of shareholders and auditors as reflected in higher bid-ask spreads, return volatility, and audit fees. Further, these consequences occur even when lender-imposed costs are relatively lower, consistent with the act of default itself triggering shareholder and auditor uncertainty. T… Show more

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Cited by 42 publications
(49 citation statements)
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“… This finding is consistent with a concurrent study that also finds a positive association between debt covenant violations and audit fees (Gao, Khan, and Tan ). However, Gao et al.…”
supporting
confidence: 92%
See 1 more Smart Citation
“… This finding is consistent with a concurrent study that also finds a positive association between debt covenant violations and audit fees (Gao, Khan, and Tan ). However, Gao et al.…”
supporting
confidence: 92%
“…This finding is consistent with a concurrent study that also finds a positive association between debt covenant violations and audit fees (Gao, Khan, and Tan 2015). However, Gao et al focus on shareholders' reactions to debt covenant violations by examining associations between violations and information asymmetry and uncertainty in the market.…”
supporting
confidence: 86%
“…The RDD is estimated non-parametrically (Hahn, Todd, and Van der Klaauw 2001;Lee and Lemieux 2010;Tan 2013;Gao, Khan, and Tan 2016) to allow flexible function forms. As Lee and Lemieux (2010) note, the inclusion of baseline covariates (independent variables) is irrelevant in the RDD given the locally randomized assignment to the treatment sample (and we verify in Section 4.1 below that firms around the threshold do not have significant differences in firm characteristics, consistent with locally randomized assignment).…”
Section: Empirical Identification Strategy and Datamentioning
confidence: 99%
“…Agency conflicts between lenders and owners/management can also create EM incentive, enhanced in the case of earnings-based debt covenants (Watts and Zimmerman, 1986;DeFond and Jiambalvo, 1994;Sweeney, 1994;Dichev and Skinner, 2002;Gao et al, 2017;Li, 2016). Note also that, especially after the Basel accords, the stability of the banking and financial system has been found to critically depend on client financial reporting transparency (Bushman and Landsman, 2010), making earnings an attribute of crucial importance.…”
Section: Demand For Audit Qualitymentioning
confidence: 99%