Non-GAAP Reporting Following Debt Covenant Violations

Review of Accounting Studies 24, no. 2 (2019): 629-664.

51 Pages Posted: 10 Mar 2015 Last revised: 6 Mar 2020

See all articles by Theodore E. Christensen

Theodore E. Christensen

University of Georgia - J.M. Tull School of Accounting; University of Georgia

Hang Pei

George Washington University - Department of Accountancy

Spencer Pierce

Florida State University - College of Business

Liang Tan

Virginia Polytechnic Institute & State University

Date Written: November 1, 2018

Abstract

We investigate whether firms change their non-GAAP reporting practices after debt covenant violations. We find that the likelihood that a firm will disclose non-GAAP earnings decreases and (for those that continue to disclose) the quality of non-GAAP reporting improves following covenant violations, consistent with stronger shareholder monitoring during this period of scrutiny. Consistent with increased monitoring following a debt covenant violation, cross-sectional analyses indicate that these changes in non-GAAP reporting are concentrated among firms with strong governance. Moreover, we find that investor demand for disclosure (proxied by analyst-provided non-GAAP performance metrics and EDGAR search volume) increases following a covenant violation. Collectively, our evidence is consistent with heightened investor scrutiny following covenant violations, and it casts doubt on the competing explanation that shareholders delegate monitoring to creditors following a covenant violation. Overall, our evidence provides new insights on the determinants of firms’ non-GAAP reporting practices and an alternative view about how debt covenant violations influence voluntary disclosure.

Keywords: Non-GAAP Earnings; Debt Contracting; Covenant Violation; Creditor Monitoring

JEL Classification: D83; G32; M40; M41

Suggested Citation

Christensen, Theodore E. and Pei, Hang and Pierce, Spencer and Tan, Liang, Non-GAAP Reporting Following Debt Covenant Violations (November 1, 2018). Review of Accounting Studies 24, no. 2 (2019): 629-664., Available at SSRN: https://ssrn.com/abstract=2575967 or http://dx.doi.org/10.2139/ssrn.2575967

Theodore E. Christensen

University of Georgia - J.M. Tull School of Accounting ( email )

Athens, GA 30602
United States

University of Georgia ( email )

Athens, GA
United States

Hang Pei

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
Washington, DC 20052
United States

Spencer Pierce

Florida State University - College of Business ( email )

423 Rovetta Business Building
Tallahassee, FL 32306-1110
United States

Liang Tan (Contact Author)

Virginia Polytechnic Institute & State University ( email )

Pamplin College of Business
Blacksburg, VA 24061
United States

HOME PAGE: http://https://acis.pamplin.vt.edu/directory/tan.html

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