Balance Sheet Conservatism and Debt Contracting

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

We study the role of borrowers' balance sheet conservatism (i.e., conservatism in asset values) in debt contract design. We find that borrowing costs are decreasing in the degree of balance sheet conservatism, and this effect is stronger for firms with lower credit quality. This is consistent with balance sheet conservatism reducing lenders' uncertainty about the liquidation value of assets, thus facilitating the ex ante screening of borrowers. We predict that better ex ante screening also reduces the need for ex post monitoring, and find that balance sheet conservatism is associated with less restrictive covenant terms. Further, we find that asymmetric timeliness in earnings is associated with lower borrowing costs only when balance sheet conservatism is not high. This result suggests that lenders appear to recognize the constraining effect of high balance sheet conservatism on future conservatism in earnings.

Original languageEnglish (US)
JournalContemporary Accounting Research
DOIs
StateAccepted/In press - Jan 1 2018

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Conservatism
Debt contracting
Balance sheet
Costs
Borrowing
Screening
Contract design
Covenant
Monitoring
Asset value
Assets
Uncertainty
Credit
Asymmetric timeliness
Debt contracts
Liquidation

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

Balance Sheet Conservatism and Debt Contracting. / Sunder, Jayanthi -; Sunder, Shyam Vallabha Josyula; Zhang, Jingjing.

In: Contemporary Accounting Research, 01.01.2018.

Research output: Contribution to journalArticle

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