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Impact of proximity to debt covenant violation on earnings management

Review of accounting studies, 2014-03, Vol.19 (1), p.473-505 [Peer Reviewed Journal]

Springer Science+Business Media New York 2013 ;Springer Science+Business Media New York 2014 ;ISSN: 1380-6653 ;EISSN: 1573-7136 ;DOI: 10.1007/s11142-013-9252-9

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  • Title:
    Impact of proximity to debt covenant violation on earnings management
  • Author: Franz, Diana R. ; HassabElnaby, Hassan R. ; Lobo, Gerald J.
  • Subjects: Accounting/Auditing ; Business and Management ; Corporate debt ; Corporate Finance ; Costs ; Covenants ; Earnings management ; Incentives ; Public Finance ; Studies
  • Is Part Of: Review of accounting studies, 2014-03, Vol.19 (1), p.473-505
  • Description: We examine the impact of differential incentives arising from proximity to debt covenant violation on earnings management. We reason that firms with loans close to violation or in technical default of their debt covenants have a stronger incentive to engage in earnings management than firms that are far from violating their debt covenants. We find results consistent with this expectation. Firms close to violation or in technical default of their debt covenants engage in higher levels of accounting earnings management, real earnings management, and total earnings management than far-from-violation firms. In additional analysis, we find that firms with a stronger incentive to avoid covenant violation switched from using more accounting earnings management before the Sarbanes–Oxley Act to using more real earnings management and more total earnings management afterwards. We also document that the earnings management implications of debt covenant violation are observed primarily for firms with poor credit ratings and for firms that do not meet analyst forecasts.
  • Publisher: Boston: Springer US
  • Language: English
  • Identifier: ISSN: 1380-6653
    EISSN: 1573-7136
    DOI: 10.1007/s11142-013-9252-9
  • Source: Alma/SFX Local Collection
    ProQuest Central
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