DEBT-COVENANT VIOLATIONS AND MANAGERS ACCOUNTING RESPONSES

This paper examines accounting changes, costs of default, and accounting-based covenants violated by 130 firms reporting violations in annual reports. I find that managers of firms approaching default respond with income-increasing accounting changes and that the default costs imposed by lenders and the accounting flexibility available to managers are important determinants of manager's accounting responses. I also document that private lending agreements are the first violated, that net worth and working capital restrictions are the most frequently violated restrictions, and that in 52 percent of the cases lenders require concessions from borrowers to resolve default.