Private Debt and Timely Loss Recognition. Issue 3 (27th May 2019)

• Record Type: Journal Article
• Authors: Franke, Benedikt; Müller, Sonja
• Is Part Of: European accounting review. Volume 28:Issue 3(2019)
• Page Start: 423
• Page End: 450
• Publication Date: 2019-05-27
• Subjects: Accounting conservatism -- Covenants -- Debt contracting -- Moral hazard; M41, G30, G32; Accounting -- Europe -- Periodicals; Accounting -- Periodicals; Comptabilité -- Europe -- Périodiques; Comptabilité -- Pays de l'Union européenne -- Périodiques; 657.094
• DOI: 10.1080/09638180.2018.1476168
• Languages: English
• ISSNs: 0963-8180

Abstract

Abstract: In this study, we investigate whether private debt contracting provides incentives for borrowers to recognize economic losses earlier in accounting earnings. Focusing on the window around firms' issuances of private loans, we document that timely loss recognition significantly increases following an issuance. This effect is significantly stronger for debt contracts that include performance covenants acting as trip-wires when firm performance deteriorates. We also find that timely loss recognition is particularly used when writing debt contracts is hampered by uncertainty about a firm's future development. These findings are consistent with timely loss recognition being used to increase contract efficiency by facilitating state-contingent control allocation based on a borrower's performance over the loan term.