I am indebted to the co-chairs of my dissertation committee, S.P. Kothari and Laurence van Lent. I thank Douglas Skinner (the editor) and the anonymous referee for constructive feedback that substantially improved the paper. I gratefully acknowledge comments from Ray Ball, Sudipta Basu, Jan Bouwens, Peter Easton, Douglas Hanna, Philip Joos, Christian Leuz, Maarten Pronk, Richard Sansing, and workshop participants at the annual American Accounting Association and European Accounting Association meetings, Emory University, MIT, Maastricht University, University of Antwerp, University of Chicago, University of Manchester, University of Michigan, University of North Carolina, and Tilburg University. This study was supported by a grant (R 46-570) from the Netherlands Organization for Scientific Research (NWO).
Debt Covenants and Accounting Conservatism
Version of Record online: 14 OCT 2009
©, University of Chicago on behalf of the Accounting Research Center, 2009
Journal of Accounting Research
Volume 48, Issue 1, pages 51–89, March 2010
How to Cite
NIKOLAEV, V. V. (2010), Debt Covenants and Accounting Conservatism. Journal of Accounting Research, 48: 51–89. doi: 10.1111/j.1475-679X.2009.00359.x
- Issue online: 15 JAN 2010
- Version of Record online: 14 OCT 2009
- Received 14 January 2008; accepted 30 September 2009
Using a sample of over 5,000 debt issues, I test whether firms with more extensive use of covenants in their public debt contracts exhibit timelier recognition of economic losses in accounting earnings. Covenants govern the transfer of decision-making and control rights from shareholders to bondholders when a company approaches financial distress and thereby limit managers’ abilities to expropriate bondholder wealth. Covenants are expected to constrain managerial opportunism, however, only if the accounting system recognizes economic losses in earnings in a timely fashion. Thus, the demand for timely loss recognition should increase with a contract's reliance on covenants. Consistent with this conjecture, I find evidence that reliance on covenants in public debt contracts is positively associated with the degree of timely loss recognition. I also find evidence that the presence of prior private debt mitigates this relationship.