Strategic Disclosure and Debt Covenant Violation

55 Pages Posted: 8 Dec 2017 Last revised: 10 Jan 2022

See all articles by Thomas Bourveau

Thomas Bourveau

Columbia University - Columbia Business School, Accounting, Business Law & Taxation

Derrald Stice

University of Hong Kong - HKU Business School

Rencheng Wang

Singapore Management University - School of Accountancy

Date Written: December 19, 2021

Abstract

This study examines how managers change their forecasting behavior as a debt covenant violation (DCV) approaches. Consistent with a change, we find that management forecasts are more optimistic in the quarter before a DCV, and this result is stronger when firms face a higher risk of shifting control rights to lenders in the event of a DCV. Furthermore, we find that managers combine their forecast optimism with actions that are favorable to shareholders but would likely be curtailed by lenders after the DCV. Specifically, we find that managers who are more optimistic in their forecasts also increase R\&D, take on more risk, and increase dividend payouts before violations. Lastly, we find managers who are more optimistic in their forecasts are less likely to be replaced after a DCV. Overall, our results are consistent with managers changing their disclosure behavior in an attempt reduce lenders' awareness of an impending DCV, and thus, buy themselves time to take actions favorable to equity investors. Furthermore, our results suggest that the actions taken by managers, though likely opposed by debtholders ex ante, may improve, on average, firms' prospects, which in turn increases managers' job security following a DCV. Our results are consistent with managers working in the interest of equity holders to minimize the costs associated with an impending DCV.

Keywords: Debt Covenant Violation, Strategic Disclosure, Risk-Shifting

Suggested Citation

Bourveau, Thomas and Stice, Derrald and Wang, Rencheng, Strategic Disclosure and Debt Covenant Violation (December 19, 2021). Journal of Management Accounting Research (2022), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3082058 or http://dx.doi.org/10.2139/ssrn.3082058

Thomas Bourveau

Columbia University - Columbia Business School, Accounting, Business Law & Taxation ( email )

3022 Broadway
New York, NY 10027
United States

Derrald Stice (Contact Author)

University of Hong Kong - HKU Business School ( email )

Hong Kong, HK
China

Rencheng Wang

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore 178900
Singapore

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