GAAP goodwill and debt contracting efficiency: evidence from net-worth covenants
Rent the article at a discountRent now
* Final gross prices may vary according to local VAT.Get Access
We study the role of goodwill in promoting contracting efficiency and the effect of SFAS 141 and 142 on this role. We provide three main results. First, when a lending agreement contains some type of minimum net-worth covenant, the probability of a tangible net-worth covenant is decreasing in the borrower’s goodwill. Second, the use of tangible net-worth covenants has increased since the promulgation of SFAS 141 and 142. Finally, covenant slack is not significantly related to the use of tangible net-worth covenants relative to net-worth covenants. These results suggest that contracting parties realize efficiency gains by permitting borrowers’ actions to be restricted by the value of GAAP goodwill. However, recent changes in GAAP have reduced the contracting usefulness of goodwill.
- Aboody, D., Kasznik, R., & Williams, M. (2000). Purchase versus pooling in stock-for-stock acquisitions: Why do firms care? Journal of Accounting & Economics, 29, 261–286. CrossRef
- Ayers, B., Lefanowicz, C., & Robinson, J. (2002). Do firms purchase the pooling method? Review of Accounting Studies, 7, 5–32. CrossRef
- Beatty, A., Weber, J., & Yu, J. (2006). Conservatism and debt, MIT working paper.
- Beatty, A., & Weber, J. (2006). Accounting discretion in fair value estimates: An examination of SFAS 142 goodwill impairments. Journal of Accounting Research, 44(2), 257–288. CrossRef
- Begley, J., & Feltham, G. (1999). An examination of the relation between debt contracts and management incentives. Journal of Accounting and Economics, 27, 229–259. CrossRef
- Billett, M., King, T., & Mayer, D. (2007). Growth opportunities and the choice of leverage, debt maturity, and covenants. Journal of Finance, 62(2), 697–730. CrossRef
- Defond, M., & Jiambalvo, J. (1994). Debt covenants violations and manipulation of accruals. Journal of Accounting and Economics, 17, 145–176. CrossRef
- Demerjian, P. (2007). Financial ratios and credit risk: The selection of financial ratio covenants in debt contracts, working paper. University of Michigan.
- Dichev, I., & Skinner, D. (2002). Large-sample evidence on the debt covenant hypothesis. Journal of Accounting Research, 40, 1091–1123. CrossRef
- El-Gazzar, S., & Pastena, V. (1990). Negotiated accounting rules in private financial contracts. Journal of Accounting and Economics, 12, 381–396. CrossRef
- Fama, E., & French, K. (1997). Industry cost of equity. Journal of Financial Economics, 43(2), 153–193. CrossRef
- Financial Accounting Standards Board. (2001a). Statement of Financial Accountings Standards No. 142: Goodwill and Other Intangible Assets.
- Financial Accounting Standards Board. (2001b). Statement of Financial Accountings Standards No. 141: Business Combinations.
- Frankel, R., & Litov, L. (2007). Financial accounting characteristics and debt covenants, working paper. Washington University.
- Galai, D., & Masulis, R. (1976). The option pricing model and the risk factor of stock. Journal of Financial Economics, 3, 53–81. CrossRef
- Kalay, A. (1982). Stockholder-bondholder conflict and dividend constraints. Journal of Financial Economics, 10, 211–233. CrossRef
- Kieso, D., Weygandt, J., & Warfield, T. (2004). Intermediate accounting (11th ed.). John Wiley & Sons, Inc.
- Leftwich, R. (1983). Accounting information in private markets: Evidence from private lending agreements. The Accounting Review, 63, 23–42.
- Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 34, 575–592. CrossRef
- Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13, 187–221. CrossRef
- Petersen, M. (2005). Estimating standard errors in finance panel data sets: comparing approaches, working paper. Northwestern University
- Smith, C., & Warner, J. (1979). On financial contracting: An analysis of bond covenants. Journal of Financial Economics, 7, 117–161. CrossRef
- Smith, C., & Watts, R. (1992). The investment opportunity set and corporate financing, dividend and compensation policies. Journal of Financial Economics, 32, 263–292. CrossRef
- Smith, C. (1993). A perspective on accounting-based debt covenants violations. The Accounting Review, 68, 289–303.
- Sweeney, A. (1994). Debt covenant violations and managers accounting responses. Journal of Accounting and Economics, 17, 281–308. CrossRef
- Watts, R. (2006). What has the invisible hand achieved? MIT Sloan School working paper.
- Weber, J. (2004). Shareholder wealth effects of pooling-of-interests accounting: Evidence from the SEC’s restriction on share repurchases following pooling transactions. Journal of Accounting & Economics, 37, 39–57. CrossRef
- Wolfson, M. (1980). Discussion of the economic effects of involuntary uniformity in the financial reporting of R&D expenditures. Journal of Accounting Research, 18, 75–83. CrossRef
- GAAP goodwill and debt contracting efficiency: evidence from net-worth covenants
Review of Accounting Studies
Volume 13, Issue 1 , pp 87-118
- Cover Date
- Print ISSN
- Online ISSN
- Springer US
- Additional Links
- Contracting efficiency
- Debt covenants
- Industry Sectors