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State Contract Law And The Use Of Accounting Information In Debt Contracts
State Contract Law And The Use Of Accounting Information In Debt Contracts
Sunay Mutlu
We study the relation between state contract law and the use of balance-sheet and income-statement based covenants in debt contracts. Incomplete contract theory suggests that balance-sheet based covenants ex ante resolve debtholder-shareholder conflicts, whereas income-statement based covenants serve as trip wires that trigger the switch of control rights ex post. Importantly, it is more difficult for lenders to exert their control rights ex post if the contract law is more favorable to debtors (i.e., the law is pro-debtor). We therefore ask whether lenders using pro-debtor law are more likely to rely on balance-sheet based covenants, and our evidence provides an …
Financial Reporting Quality And The Choice Of Monitoring Mechanisms In Debt Contracts: Evidence From Borrowing Base Restrictions
Sunay Mutlu
Borrowing base restrictions are common debt contractual features which limit the amount available to the borrower based on its working capital assets. The lender determines the availability of credit to the borrower based on the success of borrowing base assets. Identifying the unique setting of borrowing base restrictions, I examine whether financial reporting quality affects the choice of monitoring mechanisms that lenders use in debt contracts. I find that borrowers with low quality financial statements are more likely to access borrowing base lines of credit, as they face high adverse selection costs in non-borrowing base lines of credit. Accordingly, I …