Browsing by Subject "Debt Contracting"
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Item Cost-Benefit Trade-Off Of Accounting Conservatism For Bond Investors(2019-07) Sheibany, ImanI analyze the costs and benefits of accounting conservatism for debtholders by examining its effect on bond pricing. Contractual benefits of conservatism arise because it accelerates the triggering of tripwires built into earnings covenants. On the other hand, conservatism can also give rise to informational costs. The requirement of higher verification threshold for good news relative to bad news results in the pooling of some good news with bad news disclosures, increasing uncertainty when low accounting reports are observed (Gigler, Kanodia, Sapra, and Venugopalan 2009). Consistent with contractual benefits, I find that conservatism reduces bond spreads by making covenants more effective. In contrast, the increased uncertainty due to conservatism leads to higher bond spreads. Overall, I find that the informational cost of increased uncertainty exceeds the contractual benefits of conservatism resulting in higher bond spreads when accounting is conservative.