The importance of accounting changes in debt contracts: the cost of flexibility in covenant calculations |
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| Institution: | 1. Smeal College of Business, Pennsylvania State University, 215 Beam Business Adm. Building, University Park, PA 16802, USA;2. Analysis Group/Economics, Cambridge, MA 02138, USA;3. Sloan School of Management, Massachusetts Institute of Technology, Cambridge, MA 02142, USA;1. Zhejiang Wanli University, Department of International Economics and Trade, School of Business, Ningbo, China;2. Nottingham University Ningbo China, Nottingham University Business School, Ningbo, China;1. American Enterprise Institute, 1789 Massachusetts Avenue, NW, Washington, DC 20036, United States;2. Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429, United States;3. Mason School of Business, College of William & Mary, P.O. Box 8795, Williamsburg, VA 23187, United States;1. C. T. Bauer College of Business – University of Houston, United States;2. Kogod School of Business, American University, United States;3. Rutgers Business School, United States |
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| Abstract: | In this paper, we examine how the exclusion of voluntary and mandatory accounting changes from the calculation of covenant compliance affects the interest rate charged on the loan. After controlling for self-selection bias and other factors known to affect loan spreads, we find that the rate charged is 84 basis points lower when voluntary accounting changes are excluded and 71 basis points lower when mandatory accounting changes are excluded. Our results suggest that borrowers are willing to pay substantially higher interest rates to retain accounting flexibility that may help them avoid covenant violations and to avoid duplicate record-keeping costs. |
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