Additional evidence on the consequences of debt covenant violation.

Persistent Link:
http://hdl.handle.net/10150/186963
Title:
Additional evidence on the consequences of debt covenant violation.
Author:
Wilkins, Michael Stamper.
Issue Date:
1994
Publisher:
The University of Arizona.
Rights:
Copyright © is held by the author. Digital access to this material is made possible by the University Libraries, University of Arizona. Further transmission, reproduction or presentation (such as public display or performance) of protected items is prohibited except with permission of the author.
Abstract:
Positive accounting theory proposes that it is costly to violate debt covenants and, hence, that managers will be motivated to try to prevent violations from occurring (Watts and Zimmerman 1986). While early research in the debt covenant literature simply assumed that default was costly, a recent trend has been to examine firm-specific conditions in an effort to more accurately describe the nature of the costs (Beneish and Press 1993). This study is comparable in that firm-specific conditions are used to shed new light on the effects of debt covenant violation. This paper, however, focuses on the long-term consequences, as opposed to the short-term costs, of debt covenant violation and on the degree to which the market's perception of violation is a function of these consequences. Thus, the findings presented herein reveal (1) what happens to firms when they violate their debt covenants, and (2) how accurately and efficiently the financial markets impound this information. The current study utilizes a sample of 162 firms having initial debt covenant defaults between 1978 and 1988. Relative frequency analyses reveal that only 40% of these firms violate their covenants once. The remaining 60% have subsequent incidents of either technical default, monetary default, bankruptcy or liquidation. Firms forced into bankruptcy or liquidation comprise approximately 20% of the sample, suggesting that covenant violations, indeed, are not inconsequential events. In support of this, the capital markets tests reveal that equity holders do not take covenant violations lightly. Sample firms are found to experience significant increases in systematic risk and significant decreases in share prices. Furthermore, share price reactions to initial covenant violation announcements are found to be associated with the specific subsequent events (i.e., subsequent technical default, monetary default, bankruptcy and liquidation) that are faced by the violating firms. Thus, this paper reveals that the market is capable of distinguishing, at the date of initial default, between firms that will have no future default problems and firms that will face more severe consequences, such as monetary default, bankruptcy and liquidation.
Type:
text; Dissertation-Reproduction (electronic)
Keywords:
Accounting.
Degree Name:
Ph.D.
Degree Level:
doctoral
Degree Program:
Business Administration; Graduate College
Degree Grantor:
University of Arizona
Committee Chair:
Dhaliwal, Dan

Full metadata record

DC FieldValue Language
dc.language.isoenen_US
dc.titleAdditional evidence on the consequences of debt covenant violation.en_US
dc.creatorWilkins, Michael Stamper.en_US
dc.contributor.authorWilkins, Michael Stamper.en_US
dc.date.issued1994en_US
dc.publisherThe University of Arizona.en_US
dc.rightsCopyright © is held by the author. Digital access to this material is made possible by the University Libraries, University of Arizona. Further transmission, reproduction or presentation (such as public display or performance) of protected items is prohibited except with permission of the author.en_US
dc.description.abstractPositive accounting theory proposes that it is costly to violate debt covenants and, hence, that managers will be motivated to try to prevent violations from occurring (Watts and Zimmerman 1986). While early research in the debt covenant literature simply assumed that default was costly, a recent trend has been to examine firm-specific conditions in an effort to more accurately describe the nature of the costs (Beneish and Press 1993). This study is comparable in that firm-specific conditions are used to shed new light on the effects of debt covenant violation. This paper, however, focuses on the long-term consequences, as opposed to the short-term costs, of debt covenant violation and on the degree to which the market's perception of violation is a function of these consequences. Thus, the findings presented herein reveal (1) what happens to firms when they violate their debt covenants, and (2) how accurately and efficiently the financial markets impound this information. The current study utilizes a sample of 162 firms having initial debt covenant defaults between 1978 and 1988. Relative frequency analyses reveal that only 40% of these firms violate their covenants once. The remaining 60% have subsequent incidents of either technical default, monetary default, bankruptcy or liquidation. Firms forced into bankruptcy or liquidation comprise approximately 20% of the sample, suggesting that covenant violations, indeed, are not inconsequential events. In support of this, the capital markets tests reveal that equity holders do not take covenant violations lightly. Sample firms are found to experience significant increases in systematic risk and significant decreases in share prices. Furthermore, share price reactions to initial covenant violation announcements are found to be associated with the specific subsequent events (i.e., subsequent technical default, monetary default, bankruptcy and liquidation) that are faced by the violating firms. Thus, this paper reveals that the market is capable of distinguishing, at the date of initial default, between firms that will have no future default problems and firms that will face more severe consequences, such as monetary default, bankruptcy and liquidation.en_US
dc.typetexten_US
dc.typeDissertation-Reproduction (electronic)en_US
dc.subjectAccounting.en_US
thesis.degree.namePh.D.en_US
thesis.degree.leveldoctoralen_US
thesis.degree.disciplineBusiness Administrationen_US
thesis.degree.disciplineGraduate Collegeen_US
thesis.degree.grantorUniversity of Arizonaen_US
dc.contributor.chairDhaliwal, Danen_US
dc.contributor.committeememberKallapur, Sanjayen_US
dc.contributor.committeememberTrombley, Marken_US
dc.identifier.proquest9517574en_US
dc.identifier.oclc701105727en_US
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