DEBT COVENANTS VIOLATION AND EARNINGS MANAGEMENT
Mikhailova, Ekaterina (2010)
Mikhailova, Ekaterina
2010
Kuvaus
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Tiivistelmä
The present research aims to establish the relationship between closeness to debt covenants violation and earnings management. Central testable concept is debt covenants hypothesis which assumes that in reluctance of being subject to fines and penalties for non-compliance with debt covenants, managers of the borrowing firms are inclined to modify reported earnings. Following the common practice in the research area, debt-to-equity ratio is utilized as a proxy for closeness to debt covenants violation and discretionary accounting accruals are used as a substitute for earnings management. In the present work, discretionary accounting accruals are estimated by Jones (1991) model. Debt covenants hypothesis validity is examined on the sample of 102 Russian companies for the year of 2007. The analysis includes an additional variable which accounts for the impact of the degree of leverage on discretionary accruals. To control for differences in earnings management incentives, the model utilizes variables of size, profitability, stock valuation and liquidity. The effect of all factors on discretionary accounting accruals is examined by OLS regression.
The results reveal that Debt-to-Equity ratio and Dummy variable for Highly Leveraged Companies have an explanatory power over Discretionary Accounting Accruals. The relationship is negative implying that higher Debt-to-Equity ratio creates incentives for managers of the borrowing companies to use income-decreasing discretionary accruals which is aimed to present a company in a less favorable position. Possible rationale according to the previous studies suggests that the major expectation from applying such policies is getting reliefs and less restrictive conditions in loan agreements from the lenders. Liquidity is found to have a negative impact on discretionary accounting accruals suggesting that companies with lower liquidity requiring additional financing particularly in a form of cash manage their earnings upwards.
The results reveal that Debt-to-Equity ratio and Dummy variable for Highly Leveraged Companies have an explanatory power over Discretionary Accounting Accruals. The relationship is negative implying that higher Debt-to-Equity ratio creates incentives for managers of the borrowing companies to use income-decreasing discretionary accruals which is aimed to present a company in a less favorable position. Possible rationale according to the previous studies suggests that the major expectation from applying such policies is getting reliefs and less restrictive conditions in loan agreements from the lenders. Liquidity is found to have a negative impact on discretionary accounting accruals suggesting that companies with lower liquidity requiring additional financing particularly in a form of cash manage their earnings upwards.