Direct Evidence on the Informational Properties of Earnings in Loan Contracts

Posted: 15 Sep 2017

See all articles by Scott Dyreng

Scott Dyreng

Duke University - Accounting

Rahul Vashishtha

Duke University

Joseph Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: May 1, 2017

Abstract

Using a sample of firms that disclose the realizations of earnings used for determining covenant compliance in loan contracts, we provide direct evidence on the informational properties of earnings used in the performance covenants included in debt contracts. We find that the earnings measure used in performance covenants does not exhibit asymmetric loss timeliness and has significantly greater cash flow predictive ability than GAAP measures of earnings. We suggest that these results reflect the idea that contracting parties design accounting rules for performance covenants to enhance their efficacy as “tripwires.”

Keywords: earnings properties; debt contracts; cash flow prediction; conservatism

JEL Classification: G32; M40; M41

Suggested Citation

Dyreng, Scott and Vashishtha, Rahul and Weber, Joseph Peter, Direct Evidence on the Informational Properties of Earnings in Loan Contracts (May 1, 2017). Journal of Accounting Research, Vol. 55, No. 2, 2017, Available at SSRN: https://ssrn.com/abstract=3036051

Scott Dyreng

Duke University - Accounting ( email )

Box 90120, Fuqua School of Business
Durham, NC 27708-0120
United States

Rahul Vashishtha (Contact Author)

Duke University ( email )

Durham, NC 27708-0204
United States
919-660-7755 (Phone)
91-660-7971 (Fax)

Joseph Peter Weber

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States
617-253-4310 (Phone)

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