Association between restrictive covenants and accounting conservatism: evidence from US public debt

Abstract

Purpose The purpose of this paper is to investigate the relationship between restrictive covenants and accounting conservatism. More specially, the authors try to explain how the use of restrictive covenants of public debt may affect accounting conservatism. Design/methodology/approach The sample is composed of non-financial firms and for each firm one debt contract is considered. The authors have used the Ball and Shivakumar (2005) models to test the relationships. All variables were retrieved from Mergent Fixed Investment Securities and COMPUSTAT Databases. Findings The findings of this study show that the more the firm relies on bond covenants, the higher is the degree of conservatism. The authors found also that these firms also exhibited a widely significantly increased level of conservatism in the years following the issuance of debt. Research limitations/implications The results should be interpreted with caution because the use of covenants does not take into consideration the tightness of their inclusion in the public debt contract. Originality/value This paper makes a timely contribution to the debate of timely loss recognition by confirming the complementarity between the inclusion of restrictive covenants in the debt agreement and the accounting conservatism before and after the emission of public debt.