Financial Contracts, Opportunism and Disclosure Management
REVIEW OF ACCOUNTING STUDIES, Vol 1, No. 3, 1997
Posted: 20 Dec 1996
This paper shows that if all variables that determine a firm's future cash flows are not contractible, it can be ex-ante optimal to design a financial contract that admits debtholders waiving debt covenants on a discretionary basis and firms investing opportunistically subsequent to contracting. Further, as the contractible variable becomes less informative, the contract attaches greater significance to it. Finally, uncertainty in the magnitude of reporting latitude induces aggressive reporting by the firm to avoid violating the covenant or to enhance the changes of a waiver. The debtholders respond by sometimes not allowing the firm to implement mutually beneficial projects.
JEL Classification: G32, L14
Suggested Citation: Suggested Citation