Debt contracts and FAS No. 19: a test of the debt covenant hypothesis

Article Abstract:

The debt covenant hypothesis states that firms select accounting procedures to optimize leeway in debt covenant restrictions. This theory is tested using the specifics of lending agreements at the time of the release of the Financial Accounting Standard (FAS) No 19 Exposure Draft which proposes a switch to the successful-efforts method. Eighty-three debt contracts for 35 firms that use full-cost accounting were studied. Only 13 firms that had at least one covenant that would have been influenced by FAS No 19 were identified. An analysis of the stock price responses for these 13 firms, for the remaining full-cost firms, and for firms using the successful-efforts method show that changes in the likelihood of violating debt covenants are linked to the stock price response to an accounting policy decision. On the other hand, it was shown that the leverage variable does not give a sufficient proxy for this effect.

Interpretation and construction

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Predisclosure information and institutional ownership: a cross-sectional examination of market revaluations during earnings announcement periods

Article Abstract:

A study was conducted to test whether market price response to earnings announcements is smaller for securities with higher institutional holdings. Univariate and regression analyses were utilized to examine unexpected market returns that came with earnings announcements in relation to institutional ownership. The ownership composition of companies affected market reactions related to accounting disclosures and supported the process by which public disclosures of accounting data become impounded in market prices. Results showed that high institutional holdings led to low market reactions to earnings releases after controlling for security capitalization and analyst following. Institutional investors, who influence the performance of capital markets, should view accounting disclosure as a major factor that significantly affects the performance and price of securities.

Regulation, Licensing, and Inspection of Miscellaneous Commercial Sectors, Reporting & Disclosure, Investor Protection & Disclosure, Analysis, Disclosure (Securities law), Financial management, Investor relations, Disclosure statements (Accounting)

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Stock market effects of the closeness to debt covenant restrictions resulting from capitalization of leases

Article Abstract:

The relationship between the stock market returns of lessees and their changes in the tightness of the restrictions of the debt covenant as a result of compliance with Statement of Financial Accounting Standard (SFAS) No 13 is examined. A sample of lessees that retroactively capitalized leases in accordance with SFAS No 13 were studied. It was discovered that the retroactive capitalization of off-balance sheet leases can lead to the increased tightness of the debt covenant constraints. It was also shown that the affected lessees received reduced market returns at the time of the disclosure of two of the events that led to the announcement of SFAS No 13. Lastly, it was found out that private debt covenants have stricter financial restraints while public debt covenants have more nonaccounting-related provisions.

Laws, regulations and rules, Valuation, Leases, Covenants

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