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We examine the control implications of recognition versus disclosure and argue that it is easier to write more complete contracts when amounts are recognized in the financial statements, as opposed to disclosed in the footnotes. We use this framework to predict that recognition of otherwise disclosed amounts will not only increase covenant use, but also decrease covenant tightness and the cost of debt capital. We find evidence consistent with this prediction around the adoption of SFAS 158. More importantly, the results are consistent with the claim that accounting standards can affect the efficiency of debt contracts, and that lenders trade off between contracting mechanisms based on whether accounting information is recognized or disclosed.
Matthew Phillips, University of Miami
Andrew Stephen McMartin, University of Miami
John Donovan, Washington University