Melbourne Accounting Research Seminar - Pingyang Gao
Professor Pingyang Gao from Hong Kong University will present a MARS seminar.
Topic: Negotiated Accounting Measurement Rules in Debt Contracts
Abstract: We propose an incomplete debt contracting model featuring accounting-based covenants between a manager and a lender to study how accounting measurement rules can be designed to enhance the role of accounting-based covenants. Extant accounting rules may exhibit false alarm and undue optimism errors and the manager may choose to exert costly effort to privately fi nd out the suitable accounting methods that correct those errors (with some probability). The manager may also choose whether to disclose such fi ndings. In the case of non-disclosure, costly renegotiation may occur when eventually both parties fi nd out the suitability of the extant accounting rules. We find that 1) the manager has a tendency to disclose the existence of false alarm but not undue optimism errors; and 2) the manager has a tendency to exert socially wasteful effort in nding out the suitability of the extant accounting rules. Our results provide empirical and policy implications.