Management Accounting Section Midyear Meeting

Creditors’ Role in Shaping Asymmetric Cost Behavior: Evidence from Debt Covenant Violation

• In Event: Cost Structure

Abstract

This study uses covenant violations as a quasi-natural-experimental setting to examine creditors’ role in shaping corporate cost behavior. Utilizing a regression discontinuity design, I find that cost stickiness experiences a sharp decline following debt covenant violations, when control rights are transferred to creditors. The cost stickiness effect is stronger for borrowers with higher financing frictions and when creditors possess greater bargaining power. The effect is also more pronounced during industry downturns, when borrowers have fewer alternative sources of finance. Results are consistent when I use alternative measures of cost stickiness and employ alternative research designs. Overall, my evidence indicates that creditors play a monitoring role with respect to firms’ cost behavior and identifies a specific channel – loan covenants – through which the misalignment of incentives can impact cost asymmetry.

Author

• Jie Zhou, Cal State University - Fullerton