Accounting Conservatism and the Efficiency of Debt Contracts

54 Pages Posted: 6 May 2009

See all articles by Frank Gigler

Frank Gigler

University of Minnesota - Carlson School of Management

Chandra Kanodia

University of Minnesota - Carlson School of Management

Haresh Sapra

Booth School of Business, University of Chicago

Raghu Venugopalan

University of Illinois at Urbana-Champaign

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Abstract

In this paper we examine whether accounting conservatism facilitates or detracts from the efficiency of debt contracting. We consider both unconditional and conditional conservatism as discussed in the literature. In both cases, our analysis does not support the positive relationship between accounting conservatism and the efficiency of debt contracting, as suggested by Watts [2003], and as hypothesized in numerous empirical studies. In fact, we find the opposite can be true. Under very plausible conditions, we find that accounting conservatism, that affects the information content of accounting reports, actually decreases the efficiency of debt contracts. Our notion of efficiency is derived endogenously from the joint optimality of the debt covenant and the corresponding interest rate on debt, but differs from the usual efficiency notion assumed in empirical studies. We also develop and use a statistical characterization of conservatism that is new in the literature but which, we believe, is consistent with the widely accepted definition of accounting conservatism originally proposed by Basu [1997].

JEL Classification: G32, D82, M41,M44

Suggested Citation

Gigler, Frank and Kanodia, Chandra and Sapra, Haresh and Venugopalan, Raghu, Accounting Conservatism and the Efficiency of Debt Contracts. Available at SSRN: https://ssrn.com/abstract=1378295 or http://dx.doi.org/10.1111/j.1475-679X.2009.00336.x

Frank Gigler (Contact Author)

University of Minnesota - Carlson School of Management ( email )

321 19th Avenue South
Minneapolis, MN 55455
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Chandra Kanodia

University of Minnesota - Carlson School of Management ( email )

321 19th Avenue South
674 Management and Economics
Minneapolis, MN 55455
United States
612-624-6880 (Phone)
612-626-7795 (Fax)

Haresh Sapra

Booth School of Business, University of Chicago ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Raghu Venugopalan

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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