Study of Accounting Conservatism

Joybari, Azam Rezaeyan; Besheli, Fatemeh Ghasemi; Poursorkhi, Majid Amir
June 2014
Journal of Applied Sciences Research;Jun2014, Vol. 10 Issue 7, p22
Academic Journal
This paper examines the role of accounting conservatism on the design of private debt contracts. Specifically, I distinguish two arguments that offer different explanations for how accounting conservatism improves debt contracting efficiency. One argument suggests that lenders care about ex post timely loss recognition (income statement argument), and the other argument contends that lenders care about the cumulative effect of ex ante timely loss recognition (balance sheet argument). I provide evidence consistent with the balance sheet argument. Lenders reward borrowers" timely loss recognition when it leads to more reliable net asset values in the balance sheet by lowering interest rate spreads. In addition, while on average, lenders adversely price the buildup of accounting slack caused by ex ante conservative accounting practices, this penalty is absent when the accounting slack is more likely to be caused by ex ante timely loss recognition. I also find that lenders are more likely to use collateral and less likely to use financial covenants for firms with high levels of past conservatism, regardless of the source of conservatism. Taken together, the results show that it is important to distinguish the type and source of conservatism. Overall, the results suggest that the role of accounting conservatism in debt contracting is more complex than documented in prior literature.


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