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Earnings Management to Avoid Debt Covenant Violations and Future Performance

Publication ,  Journal Article
Dyreng, SD; Hillegeist, SA; Penalva, F
Published in: European Accounting Review
January 1, 2022

In this study, we examine the trade-offs between earnings management (both accruals and real) and covenant violations by examining how they are associated with future accounting and stock market performance. We analyze a matched-pair sample of covenant violation firms with non-violation firms that have a similar risk of a covenant violation. We have three main findings. First, our evidence indicates that covenant violations are costly events for shareholders as lenders appear to use their control rights in ways that increase the likelihood of loan repayment but impose costs for shareholders. Second, there is limited evidence indicating covenant-related accrual-earnings management activities impose significant costs on shareholders, but we find shareholders are worse off following unsuccessful real earnings management. Third, our evidence indicates that, on average, shareholders at high violation risk firms are better off when their firms successfully engage in accruals earnings management to avoid a violation compared to shareholders at firms that violate a covenant but do not manage earnings. Thus, covenant-related earnings management may be in the best interests of shareholders and is not necessarily evidence of shareholder-manager agency conflicts.

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Published In

European Accounting Review

DOI

EISSN

1468-4497

ISSN

0963-8180

Publication Date

January 1, 2022

Volume

31

Issue

2

Start / End Page

311 / 343

Related Subject Headings

  • Accounting
  • 3501 Accounting, auditing and accountability
  • 1501 Accounting, Auditing and Accountability
 

Citation

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Dyreng, S. D., Hillegeist, S. A., & Penalva, F. (2022). Earnings Management to Avoid Debt Covenant Violations and Future Performance. European Accounting Review, 31(2), 311–343. https://doi.org/10.1080/09638180.2020.1826337
Dyreng, S. D., S. A. Hillegeist, and F. Penalva. “Earnings Management to Avoid Debt Covenant Violations and Future Performance.” European Accounting Review 31, no. 2 (January 1, 2022): 311–43. https://doi.org/10.1080/09638180.2020.1826337.
Dyreng SD, Hillegeist SA, Penalva F. Earnings Management to Avoid Debt Covenant Violations and Future Performance. European Accounting Review. 2022 Jan 1;31(2):311–43.
Dyreng, S. D., et al. “Earnings Management to Avoid Debt Covenant Violations and Future Performance.” European Accounting Review, vol. 31, no. 2, Jan. 2022, pp. 311–43. Scopus, doi:10.1080/09638180.2020.1826337.
Dyreng SD, Hillegeist SA, Penalva F. Earnings Management to Avoid Debt Covenant Violations and Future Performance. European Accounting Review. 2022 Jan 1;31(2):311–343.

Published In

European Accounting Review

DOI

EISSN

1468-4497

ISSN

0963-8180

Publication Date

January 1, 2022

Volume

31

Issue

2

Start / End Page

311 / 343

Related Subject Headings

  • Accounting
  • 3501 Accounting, auditing and accountability
  • 1501 Accounting, Auditing and Accountability