The Signaling Role of Accounting Conservatism in Debt Contracting

46 Pages Posted: 16 Apr 2010 Last revised: 15 Aug 2010

See all articles by Ying-Ju Chen

Ying-Ju Chen

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management

Mingcherng Deng

City University of New York (CUNY) - Baruch College

Date Written: August 15, 2010

Abstract

TThere has been debate over the economic consequences of accounting conservatism in debt contracting. We contribute to this debate by arguing that the prospect of signaling project return may give rise to the demand for conservative accounting, even though it may not improve contracting efficiency ex post. The empirical evidence of the negative correlation between interest rates and conservative accounting may be explained by the heterogeneity among firms, such as riskiness, leverage and the strength of balance sheet. While debt covenants may also serve as a signaling device, they lead to a lower Type-I error, but a higher Type-II error, than signaling via accounting conservatism. Our results further indicate that conditional conservatism may either alleviate or amplify the distortion required for the signaling purpose.

Keywords: accounting conservatism, debt covenants, signaling

JEL Classification: M41, M44, G21, G32

Suggested Citation

Chen, Ying-Ju and Deng, Mingcherng, The Signaling Role of Accounting Conservatism in Debt Contracting (August 15, 2010). Available at SSRN: https://ssrn.com/abstract=1590577 or http://dx.doi.org/10.2139/ssrn.1590577

Ying-Ju Chen

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management ( email )

Clear Water Bay
Kowloon
Hong Kong

Mingcherng Deng (Contact Author)

City University of New York (CUNY) - Baruch College ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
698
Abstract Views
3,826
Rank
68,379
PlumX Metrics