Conditional conservatism and debt versus equity financing

SMU SOA

On the welfare effects of allowing unlimited renegotiation in agency relationships

Principal–agent problem, Limited versus unlimited renegotiations, Value of limiting commitment, C70, D82, D83, D86,

On the Value of Transparency in Agencies with Renegotiation

In this paper we study when it is advantageous to improve corporate transparency by allowing shareholders direct access to corporate information and when it is preferable to rely on a reporting system in which shareholders only gain access to information that management chooses to disclose. We show that in an agency model that allows for contract renegotiation, the desirability of a fully transparent reporting regime hinges on the stewardship properties of the information in question. Specifically, information that is mainly useful for predicting future events and of little use for evaluating past actions should only be made available to the public through management's self-interested disclosures. Only if the information is useful for making inference about managerial actions can it be optimal to have full corporate transparency, so that outsiders have independent access to the same information as management. Copyright University of Chicago on behalf of the Institute of Professional Accounting, 2004.

Accounting Conservatism and the Efficiency of Debt Contracts

ABSTRACT In this paper we examine how accounting conservatism affects the efficiency of debt contracting. We develop the statistical and informational properties of accounting reports under varying degrees of conditional and unconditional accounting conservatism, consistent with Basu's [1997] description of differential verifiability standards. Optimal debt covenants and interest rates on debt are derived from a natural tension between debt holders and equity claimants. We show how optimal covenants vary with the degree of conservatism and derive an efficiency metric that depends on the degree of conservatism. We find that accounting conservatism actually "decreases" the efficiency of debt contracts, contrary to the suggestions of Watts [2003] and contrary to the hypothesis in numerous empirical studies. Copyright (c), University of Chicago on behalf of the Institute of Professional Accounting, 2009.