Debt covenant slack and ex-post conditional accounting conservatism. Issue 2 (23rd February 2020)

• Record Type: Journal Article
• Authors: Kim, Bong Hwan
• Is Part Of: Accounting and business research. Volume 50:Issue 2(2020)
• Page Start: 111
• Page End: 134
• Publication Date: 2020-02-23
• Subjects: debt covenant hypothesis -- conditional accounting conservatism -- asymmetric timeliness -- accruals; Accounting -- Periodicals; Accounting -- Research -- Periodicals; Business -- Periodicals; Comptabilité -- Périodiques; Comptabilité -- Recherche -- Périodiques; Affaires -- Périodiques; Accounting; Electronic journals; 658.15
• DOI: 10.1080/00014788.2019.1663720
• Languages: English
• ISSNs: 0001-4788

Abstract

Abstract : This study examines how conditional accounting conservatism varies after debt contracts are executed (ex-post conditional conservatism) depending on the closeness to violations of debt covenants, the costs of covenant violations, and bank monitoring. I hypothesise that borrowers with lower debt-covenant slack have an incentive to avoid covenant violations and will have lower ex-post conditional conservatism levels than those with higher slack. I find that borrowers with both lower and higher slack increase their ex-post conditional conservatism, but that the magnitude of this increase in conservatism is positively associated with the level of covenant slack. Further, this positive relationship between the ex-post change in conditional conservatism and the debt-covenant slack is more pronounced when the costs of the debt-covenant breach are greater, and is less pronounced when lenders have stronger incentives to monitor borrowers. This study provides evidence that the ex-post change in conditional conservatism is affected by the costs of a covenant breach and bank monitoring.