The effect of accounting-based debt covenants on equity valuation 1 We appreciate the helpful comments of Jeff Abarbanell, Ray Ball (the editor), Mike Barclay, Jennifer Francis, Chris Géczy, Bruce Grundy, Wayne Guay, Bob Holthausen, Ken Klassen, S.P. Kothari, Mark Lang, Krishna Ramaswamy, Katherine Schipper, Beverly Walther, seminar participants at the University of Chicago, Harvard University, University of North Carolina, Northwestern University, Pennsylvania State University, University of Rochester, Stanford University, University of Waterloo, and the Wharton School, and especially the useful suggestions of Paul Fischer and Sudipta Basu (the referee). We appreciate the financial support of the Wharton Financial Institutions Center. 1

The effect of accounting-based debt covenants on equity valuation 1 We appreciate the helpful... We use an option pricing framework to model equity valuation when firms face costs associated with violating accounting-based debt covenants. Our model shows that the value of equity depends on two factors: the economic value of the firm and the probability that the firm violates the covenant. Consistent with the model's prediction that the `covenant' effect is greatest for firms near covenant violation, we find that responses to earnings that are less informative about future cash flows (losses and transitory earnings) are significant only for thrift institutions that are near violation of regulatory net worth covenants. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Accounting and Economics Elsevier

The effect of accounting-based debt covenants on equity valuation 1 We appreciate the helpful comments of Jeff Abarbanell, Ray Ball (the editor), Mike Barclay, Jennifer Francis, Chris Géczy, Bruce Grundy, Wayne Guay, Bob Holthausen, Ken Klassen, S.P. Kothari, Mark Lang, Krishna Ramaswamy, Katherine Schipper, Beverly Walther, seminar participants at the University of Chicago, Harvard University, University of North Carolina, Northwestern University, Pennsylvania State University, University of Rochester, Stanford University, University of Waterloo, and the Wharton School, and especially the useful suggestions of Paul Fischer and Sudipta Basu (the referee). We appreciate the financial support of the Wharton Financial Institutions Center. 1

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Publisher
Elsevier
Copyright
Copyright © 1999 Elsevier Science B.V.
ISSN
0165-4101
DOI
10.1016/S0165-4101(98)00043-3
Publisher site
See Article on Publisher Site

Abstract

We use an option pricing framework to model equity valuation when firms face costs associated with violating accounting-based debt covenants. Our model shows that the value of equity depends on two factors: the economic value of the firm and the probability that the firm violates the covenant. Consistent with the model's prediction that the `covenant' effect is greatest for firms near covenant violation, we find that responses to earnings that are less informative about future cash flows (losses and transitory earnings) are significant only for thrift institutions that are near violation of regulatory net worth covenants.

Journal

Journal of Accounting and EconomicsElsevier

Published: Feb 1, 1999

References

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