Negotiated Measurement Rules in Debt Contracts

Li, Ningzhong

doi:10.2139/ssrn.1464295

Cited by 48 publications

(51 citation statements)

References 53 publications

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“…14 Prior research explores instances in which lenders make adjustments to GAAP accounting. For example, Beatty et al (2008) find an association between income escalators in net worth covenants and accounting conservatism, while Li (2009) finds evidence of adjustments for transitory components in contractual definitions of earnings and net assets.…”

Section: Bank Debt Covenantsmentioning

confidence: 99%

Bank debt covenants and firms’ responses to FAS 150 liability recognition: evidence from trust preferred stock

2011

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We examine the relation between accounting-based debt contracts and the economic response of firms with trust preferred stock (TPS) to mandated liability recognition under Financial Accounting Standard (FAS) 150. Our results show that firms' financial covenants significantly affect their choice to redeem versus reclassify their outstanding TPS. Specifically, firms with bank debt covenants that would be adversely impacted by recognizing TPS as a debt liability are 26.88% more likely to redeem their TPS after FAS 150. We also find that firms are significantly more likely to redeem versus reclassify their TPS after FAS 150 if they used the original TPS proceeds to retire existing debt (id est, to enhance their balance sheets). Our findings suggest that when bank debt contracts use ''floating'' Generally Accepted Accounting Principles (GAAP) to construct financial covenant terms, changes in the underlying GAAP measure significantly influence firms' economic behavior.

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Section: Bank Debt Covenantsmentioning

confidence: 99%

Bank debt covenants and firms’ responses to FAS 150 liability recognition: evidence from trust preferred stock

2011

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“…There is little or no corresponding effect on income statement-based covenants because these covenants tend to use an adjusted earnings number (such as EBIT or EBITDA) that is naturally insulated from the effect of GAAP changes, as previously recognized in the literature (e.g., Li, 2010).…”

Section: Changes In Debt Contractingmentioning

confidence: 99%

Discussion of “Accounting standards and debt covenants: Has the “Balance Sheet Approach” led to a decline in the use of balance sheet covenants?”

Skinner

2011

Journal of Accounting and Economics

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“…Wittenberg-Moerman (2008) examines whether conservatism decreases information asymmetry for borrowers and finds lower bid-ask spread in the secondary loan market for firms with higher conservatism. Consistent with the usefulness of conservatism in debt contracting, several studies document that conservatism plays an important role in shaping debt contracts (Beatty et al 2008;Ball, Bushman, et al 2008;Li 2010;Nikolaev 2010). 7 Ball , Robin, et al (2008) document that the demand for conservatism is primarily driven by debt rather than by equity markets.…”

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confidence: 96%

Conditional Conservatism and Debt versus Equity Financing

Goh

Lim

Lobo

et al. 2016

Contemporary Accting Res

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Extant research suggests that conditional conservatism reduces information asymmetry between a firm and its shareholders as well as its debtholders. However, there is little evidence on whether conditional conservatism reduces information asymmetry differentially for shareholders and debtholders. We use the setting of a firm's choice between equity versus debt when it seeks a significant amount of external financing to examine this research question. We find that when firms raise a significant amount of external financing, the use of equity (versus debt) increases with the level of conservatism. We also find that the reduction in cost of equity associated with conservatism is greater for equity issuers than for debt issuers, but find no such difference when we examine cost of debt. In addition, we find that the positive effect of conservatism on the choice of equity issuance (versus debt issuance) is accentuated when the information asymmetry between the firm and its shareholders is more severe. Overall, our results suggest that conservatism reduces information asymmetry more between firms and shareholders than between firms and debtholders. Prudence conditionnelle et financement par emprunt ou par capitaux propres R ESUM E Selon les etudes existantes, la prudence conditionnelle r eduit l'asym etrie de l'information entre une soci et e et ses actionnaires de m^ eme que ses cr eanciers. Toutefois, rares sont les donn ees concluantes quant a savoir si cette r eduction de l'asym etrie de l'information attri-buable a la prudence conditionnelle diff ere pour les actionnaires et les cr eanciers. Pour etu-dier la question, les auteurs utilisent le contexte du choix d'une soci et e entre le financement par capitaux propres ou par emprunt lorsque ses besoins de financement externe sont importants. Ils constatent que, dans le cas des soci et es dont ces besoins sont importants, le recours aux capitaux propres (par opposition au recours a l'emprunt) augmente avec le degr e de prudence. Les auteurs observent egalement que la r eduction du co^ ut des capitaux propres associ ee a la prudence est plus importante dans le cas des soci et es emettrices d'ac-tions que dans celui des soci et es emettrices de titres de cr eance, mais ils ne rel event aucun ecart de cette nature pour ce qui est de co^ ut de la dette. Ils constatent en outre que * Accepted by Sudipta Basu. We thank Sudipta Basu, Patricia O'Brien, two anonymous reviewers, Zeyun l'incidence positive de la prudence sur le choix de l' emission d'actions (plut^ ot que de titres de cr eance) s'accentue lorsque l'asym etrie de l'information entre la soci et e et ses actionnai-res est plus marqu ee. Dans l'ensemble, les r esultats de l' etude semblent indiquer que la prudence r eduit davantage l'asym etrie de l'information entre les soci et es et les actionnaires qu'entre les soci et es et les cr eanciers.

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Negotiated Measurement Rules in Debt Contracts

Cited by 48 publications

References 53 publications

Bank debt covenants and firms’ responses to FAS 150 liability recognition: evidence from trust preferred stock

Bank debt covenants and firms’ responses to FAS 150 liability recognition: evidence from trust preferred stock

Discussion of “Accounting standards and debt covenants: Has the “Balance Sheet Approach” led to a decline in the use of balance sheet covenants?”

Conditional Conservatism and Debt versus Equity Financing

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