State contract law and the use of accounting information in debt contracts
This paper examines the relation between state contract law and the use of accounting information in debt contracts. Contract theory suggests that balance sheet based covenants resolve debtholder-shareholder conflicts ex ante, whereas income statement based covenants serve as trip- wires that trigge...
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Published in | Review of accounting studies Vol. 26; no. 1; pp. 124 - 171 |
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Main Authors | , , , |
Format | Journal Article |
Language | English |
Published |
New York
Springer US
01.03.2021
Springer Nature B.V |
Subjects | |
Online Access | Get full text |
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Abstract | This paper examines the relation between state contract law and the use of accounting information in debt contracts. Contract theory suggests that balance sheet based covenants resolve debtholder-shareholder conflicts ex ante, whereas income statement based covenants serve as trip- wires that trigger the switch of control rights ex post. It is more difficult for lenders to exert their control rights ex post if the contract law is more favorable to debtors (i.e., the law is pro-debtor), suggesting that balance sheet based covenants are more efficient in these jurisdictions. We therefore test and find evidence that lenders using pro-debtor (pro-lender) law are more (less) likely to rely on balance sheet based covenants. We measure reliance using both the weight of balance sheet covenants relative to income statement covenants and the covenant strictness. Our analysis further shows that contracts with performance pricing grids are less likely to include interest increasing grids when the law is more favorable to debtors. The results provide initial evidence that contract law is an important determinant for the design of debt contracts. |
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AbstractList | This paper examines the relation between state contract law and the use of accounting information in debt contracts. Contract theory suggests that balance sheet based covenants resolve debtholder-shareholder conflicts ex ante, whereas income statement based covenants serve as trip- wires that trigger the switch of control rights ex post. It is more difficult for lenders to exert their control rights ex post if the contract law is more favorable to debtors (i.e., the law is pro-debtor), suggesting that balance sheet based covenants are more efficient in these jurisdictions. We therefore test and find evidence that lenders using pro-debtor (pro-lender) law are more (less) likely to rely on balance sheet based covenants. We measure reliance using both the weight of balance sheet covenants relative to income statement covenants and the covenant strictness. Our analysis further shows that contracts with performance pricing grids are less likely to include interest increasing grids when the law is more favorable to debtors. The results provide initial evidence that contract law is an important determinant for the design of debt contracts. |
Author | Mutlu, Sunay Honigsberg, Colleen Katz, Sharon P. Sadka, Gil |
Author_xml | – sequence: 1 givenname: Colleen surname: Honigsberg fullname: Honigsberg, Colleen email: colleenh@law.stanford.edu organization: Stanford Law School – sequence: 2 givenname: Sharon P. surname: Katz fullname: Katz, Sharon P. organization: INSEAD – sequence: 3 givenname: Sunay surname: Mutlu fullname: Mutlu, Sunay organization: Kennesaw State University – sequence: 4 givenname: Gil surname: Sadka fullname: Sadka, Gil organization: University of Texas at Dallas |
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Keywords | Pricing grids Balance sheet based covenants G30 Income statement based covenants G21 Contract law M41 Debt contracts K12 |
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Snippet | This paper examines the relation between state contract law and the use of accounting information in debt contracts. Contract theory suggests that balance... |
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SubjectTerms | Accounting/Auditing Balance sheets Business and Management Contract law Corporate Finance Covenants Debt Public Finance State court decisions |
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Title | State contract law and the use of accounting information in debt contracts |
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