Accounting Theory Is The Debt Covenant

1635 Words Nov 22nd, 2015 7 Pages
(2) Debt covenant motives
Another important hypothesis of accounting theory is the debt covenant hypothesis. The violation of the debt covenant implies, shows that the instability when company operates its business. Also, it means that there exists the volatility in major accounting measures, like earnings and liquidity, even though will increase the possibility of risk of a bankrupt (DeFond and Jiambalvo,1994). Furthermore, it also describes a negative company performance to public to make an impact on stock price, reliability as well as the reputation of the managers (Holthausen,Larcker &Sloan, 1995). It is therefore the managers of a firm who have a lot of borrowing are more motivated to avoid the negative effects and manage earnings positively to ensure that they are abiding by their debt covenant. On the other hand, Sweeney (1994) found that so as to reduce the possibility of debt covenant violation, the managers are more likely to choose to engage in earnings management by using accruals to increase income.

(3) political cost motives
Due to the fact that the society and the market pays more attention on super large-scale enterprises, the earnings management becomes one of the methods to lessen the degree of attention. It can be found obviously from Jones(1991) research that during the investigating period of United States International Trade Commission, the firms under investigation are more motivated to adjust accrual incomes in financial statements than other…

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