The Impact of Financial Covenants in Private Loan Contracts on Classification Shifting

• 成果类型: Article
• 署名作者: Fan, Yun; Thomas, Wayne B.; Yu, Xiaoou
• 署名单位: University of Texas System; University of Texas Arlington; University of Oklahoma System; University of Oklahoma - Norman; Xiamen University
• 刊物名称: MANAGEMENT SCIENCE
• ISSN/ISSBN: 0025-1909
• DOI: 10.1287/mnsc.2018.3110
• 发表日期: 2019
• 页码: 3637-3653
• 关键词: classification shifting; debt covenant; Private loans; EBITDA; special items

摘要

This study examines whether firms with private loan contracts that contain debt covenants based on earnings before interest, taxes, depreciation, and amortization (EBITDA) are more likely to misclassify core expenses as special items (i.e., classification shift). Misclassifying core expenses as income-decreasing special items allows the firm to increase EBITDA and thereby potentially avoid debt covenant violations. Consistent with our expectation, firms misclassify core expenses as special items when at least one EBITDA-related financial covenant is close to being violated. In addition, classification shifting is more prominent when financially distressed firms are close to violating at least one EBITDA-related covenant. Whereas prior research on classification shifting focuses primarily on equity market incentives (e.g., meeting analysts' earnings forecasts), our study extends this research to private loan contracts to highlight that creditors also affect classification shifting. Classification shifting appears to be an additional earnings management technique used by managers to avoid debt covenant violations.