Bank intervention and firms’ earnings management: evidence from debt covenant violations

Yichu Huang (), Lei Chen () and Frank Hong Liu ()
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Yichu Huang: East China University of Political Science and Law
Lei Chen: Loughborough University
Frank Hong Liu: Loughborough University

Review of Quantitative Finance and Accounting, 2024, vol. 63, issue 1, No 8, 237-264

Abstract: Abstract Earnings management has long been one of the main concerns in accounting and management literature, and the extent to which corporate governance mechanisms can discipline management behaviour and prevent earnings management has attracted increasing interest among policy makers and academic researchers. Differing from previous corporate governance literature that focuses mainly on the board and auditors, we explore the role of creditors in corporate governance. In particular, we examine the effect of bank intervention on earnings management via the lens of debt covenant violations, where control rights are transferred to creditors (banks). Using a Difference-in-Difference approach, we find that firms reduce both their accruals-based and real earnings management following debt covenant violations. The negative effect on earnings management is more prominent when banks possess greater bargaining and monitoring power and when firms are more financially constrained. By identifying a specific channel through which debt providers influence corporate financial reporting, our findings suggest that creditors can play an important role in governing organisations and disciplining management behaviour.

Keywords: Corporate governance; Bank intervention; Earnings management; Debt covenant violation (search for similar items in EconPapers)
JEL-codes: G20 G30 M41 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s11156-024-01255-7

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