Income Smoothing and the Usefulness of Earnings for Monitoring in Debt Contracting

• 成果类型: Article
• 署名作者: Demerjian, Peter; Donovan, John; Lewis-Western, Melissa F.
• 署名单位: University of Illinois System; University of Illinois Chicago; University of Illinois Chicago Hospital; University of Notre Dame; Brigham Young University
• 刊物名称: CONTEMPORARY ACCOUNTING RESEARCH
• ISSN/ISSBN: 0823-9150
• DOI: 10.1111/1911-3846.12544
• 发表日期: 2020
• 页码: 857-884
• 关键词: ACCOUNTING CONSERVATISM; corporate governance; covenant violation; INFORMATION; QUALITY; firm; IMPACT; COSTS; volatility; INVESTMENT

摘要

We investigate whether income smoothing affects the usefulness of earnings for contracting through the monitoring role of earnings-based debt covenants. First, we examine initial contract design and predict that income smoothing will increase (decrease) the use of earnings-based covenants if income smoothing improves (reduces) the usefulness of earnings to monitor borrowers. We find that private debt contracts to borrowers with greater income smoothing are more likely to include earnings-based covenants. A structural model that explores the cause of this relationship provides evidence that smoothing improves the ability of earnings to reflect credit risk. Second, we examine technical default following contract inception. We find that income smoothing is associated with a lower likelihood of spurious technical default (when the borrower's economic performance has not declined but the loan nevertheless enters technical default). In contrast, we find no association between income smoothing and performance technical default (when the borrower's economic performance has declined). Collectively, this evidence is consistent with income smoothing improving the effectiveness of earnings-based information in monitoring borrowers.