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Earnings Management Response to Debt Covenant Violations and Debt Restructuring

Earnings Management Response to Debt Covenant Violations and Debt Restructuring The study investigates whether the choice of income-increasing or income-decreasing discretionary accruals is related to the severity of financial distress and whether this choice is also influenced by the creditors' waivers of debt covenant violations. Financially distressed firms experiencing debt covenant violations and/or debt restructuring during the 1989–96 period are used to evaluate the management's choice of discretionary accruals. Discretionary accruals are calculated based on four different accrual models.The results show that managers of financial distressed firms use income-increasing discretionary accruals if they are able to obtain waivers for debt covenant violations, and use income-decreasing discretionary accruals if debt restructuring takes place or debts are renegotiated because waivers are denied. These findings thus provide support to the expectation that the choice of income-increasing or -decreasing discretionary accruals is influenced by the severity of financial distress. They also provide an explanation for divergence in the results of earlier studies on the use of income-increasing or -decreasing discretionary accruals by financially distressed firms. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png "Journal of Accounting, Auditing & Finance" SAGE

Earnings Management Response to Debt Covenant Violations and Debt Restructuring

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References (30)

Publisher
SAGE
Copyright
© 2002 SAGE Publications
ISSN
0148-558X
eISSN
2160-4061
DOI
10.1177/0148558X0201700402
Publisher site
See Article on Publisher Site

Abstract

The study investigates whether the choice of income-increasing or income-decreasing discretionary accruals is related to the severity of financial distress and whether this choice is also influenced by the creditors' waivers of debt covenant violations. Financially distressed firms experiencing debt covenant violations and/or debt restructuring during the 1989–96 period are used to evaluate the management's choice of discretionary accruals. Discretionary accruals are calculated based on four different accrual models.The results show that managers of financial distressed firms use income-increasing discretionary accruals if they are able to obtain waivers for debt covenant violations, and use income-decreasing discretionary accruals if debt restructuring takes place or debts are renegotiated because waivers are denied. These findings thus provide support to the expectation that the choice of income-increasing or -decreasing discretionary accruals is influenced by the severity of financial distress. They also provide an explanation for divergence in the results of earlier studies on the use of income-increasing or -decreasing discretionary accruals by financially distressed firms.

Journal

"Journal of Accounting, Auditing & Finance"SAGE

Published: Oct 1, 2002

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