Accounting Quality and Debt Concentration: Evidence from Internal Control Weakness Disclosures

• In Event: Accounting Quality and Internal Controls

Abstract

This paper examines the role of accounting quality in creditor coordination by
investigating the effect of accounting quality on the degree of debt concentration in
corporate capital structures (i.e., a firm’s tendency to predominantly rely on only a few
types of debt). Motivated by theoretical and empirical research that supports a strong
link between creditors’ coordination costs and debt concentration and the importance
of accounting quality in reducing these coordination costs, we hypothesize that firms
with low accounting quality have a more concentrated debt structure in order to reduce
the costs of financial distress and consequently the cost of their debt financing.
Measuring financial reporting quality by the disclosure of material internal control
weaknesses over financial reporting (ICWs), we find that ICWs lead to a significantly
more concentrated debt structure. We also show that the effect of the ICWs on the
degree of debt concentration is stronger for more severe ICW disclosures and for firms
with higher credit risk, further reinforcing the importance of financial reporting quality
in reducing inefficiencies in creditor coordination.

Authors

• Ningzhong Li, University of Texas-Dallas

• Yun Lou, HEC PARIS

• Clemens Otto, HEC Paris

• Regina Wittenberg-Moerman, University of Southern California