We are grateful to the Editor (Douglas Skinner), an anonymous reviewer, Ray Ball, Philip Berger, Jeffrey Burks, Craig Chapman, Gus De Franco, Peter Easton, Bob Holthausen, Christian Leuz, Ningzhong Li, Abbie Smith, Jayanthi Sunder, Florin Vasvari, Daniel Wilhelm, Wayne Guay (discussant) and participants at Utah Winter Accounting Conference, and seminar participants at McGill University, Northwestern University, the University of Chicago, the University of Notre Dame and the AAA 2010 Annual Meeting for valuable comments and helpful discussions.
The Impact of Financial Reporting Quality on Debt Contracting: Evidence from Internal Control Weakness Reports
Article first published online: 6 DEC 2010
©, University of Chicago on behalf of the Accounting Research Center, 2011
Journal of Accounting Research
Volume 49, Issue 1, pages 97–136, March 2011
How to Cite
COSTELLO, A. M. and WITTENBERG-MOERMAN*, R. (2011), The Impact of Financial Reporting Quality on Debt Contracting: Evidence from Internal Control Weakness Reports. Journal of Accounting Research, 49: 97–136. doi: 10.1111/j.1475-679X.2010.00388.x
- Issue published online: 18 JAN 2011
- Article first published online: 6 DEC 2010
- Accepted manuscript online: 19 OCT 2010 02:25AM EST
- Received 17 August 2009; accepted 1 September 2010
We examine the effect of financial reporting quality on the trade-off between monitoring mechanisms used by lenders. We rely on Sarbanes-Oxley internal control reports to measure financial reporting quality. We find that when a firm experiences a material internal control weakness, lenders decrease their use of financial covenants and financial-ratio-based performance pricing provisions and substitute them with alternatives, such as price and security protections and credit-rating-based performance pricing provisions. We also find that changes in debt contract design following internal control weaknesses are substantially different from those following restatements, where lenders impose tighter monitoring on managers’ actions, but do not decrease their use of financial statement numbers.