ABSTRACT

We investigate whether characteristics of firms' debt structure, beyond leverage and debt covenants, are associated with predictable variation in conditional conservatism. The contracting theory of conservatism holds that conditional conservatism is an efficient mechanism employed by an organization to address agency conflict arising from contracts with various parties. For firms with contracts that are associated with more agency conflict, the potential benefit of a conservative reporting strategy should increase. We examine the following debt contract characteristics: (1) convertibility, (2) securitization, (3) seniority, and (4) placement. We find that debt types thought to be associated with a downward shift in agency conflict (convertible, secured, senior, and private debt) are associated with less conservative reporting. Our evidence supports contracting theory as being descriptive of the link between debt and conservatism. Also, our evidence corroborates the assertion that debt contract modifications do not fully resolve lenders' demands for conservative reporting.

JEL Classifications: M41; D21; D82; G14.

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