Guay (1998, Journal of Accounting and Economics, this issue) addresses potential endogeneity biases in cross-sectional studies of derivative use by examining derivative initiations. When derivatives are only part of a risk-management strategy, tests comparing derivative users versus non-users may be biased. One solution to this difficult problem is to examine an exogenous change in derivative use. Guay (1998)identifies a recent reduction in transactions costs as a potential exogenous shock to derivative use. However, if cost reductions cannot explain derivative initiations, then his analysis may not eliminate the biases in previous research. Studies isolating alternative exogenous changes in firms’ risk management strategies may provide further insights.

Internal control regulation effectiveness remains controversial given the recent financial crisis. To address this issue we examine the financial reporting effects of the Federal Depository Insurance Corporation Improvement Act (FDICIA) internal control provisions. Exemptions from these provisions for banks with assets under $500 million and for non-US banks provides two unaffected control samples. Our difference-in-differences method suggests that FDICIA-mandated internal control requirements increased loan-loss provision validity, earnings persistence and cash-flow predictability and reduced benchmark-beating and accounting conservatism for affected versus unaffected banks. More pronounced effects in interim versus fourth quarters suggest that greater auditor presence substitutes for internal control regulation.

Performance pricing links bank debt interest rate spreads to a borrower's performance via two options. Interest-decreasing performance pricing reduces spreads if credit quality improves. It is more common when prepayment is more likely or costly and when adverse selection costs are higher, and is less common when multiple performance measures better predict credit quality. Interest-increasing performance pricing increases spreads if credit quality deteriorates. It is more common when lenders reduce interest rates to add this provision, when downgrades are more likely, and when moral hazard costs are higher. We find lower spreads for contracts with interest increasing performance pricing.

This study examines whether the provisions of a firm's bank debt contracts affect its accounting choices. Starting with a sample of firms who have bank debt and who also voluntarily changed accounting methods, we investigate whether the likelihood that the change in accounting method increased (rather than decreased) the borrower's income depends on (1) whether the change in accounting method affects the bank debt contract calculations, (2) the expected costs of violating the bank debt covenants, (3) whether performance pricing provisions affect the interest rate on the loan, and (4) whether the bank debt contract contains accounting-based dividend restrictions. After controlling for other motives for changing accounting methods, we find that borrowers whose bank debt contracts allow accounting method changes to affect contact calculations are more likely to make income-increasing rather than income-decreasing changes. This increase in likelihood of an income-increasing change is attenuated when expected costs of technical violation are lower because there is a single lender, and occurs for borrowers whose debt contacts have performance pricing and dividend restrictions. These results suggest that incentives to lower interest rates through performance pricing or to retain dividend payment flexibility influence borrowers' accounting method choices, thereby addressing the fundamental questions posed by Fields et al. (2001) of whether, under what circumstances, and how accounting choice matters.

Les auteurs étudient comment l’information privilégiée et le contrôle continu influent sur le rôle de la qualité de la comptabilité dans la réduction de la sensibilité des investissements aux flux de trésorerie. Selon eux, l’accès à l’information privilégiée et les restrictions directes dont les investissements font l’objet sont susceptibles d’influer sur la mesure dans laquelle la qualité de la comptabilité réduit les contraintes financières. Les résultats de l’étude semblent indiquer que, dans le cas des sociétés soumises à des contraintes financières, l’accès des banques à l’information privilégiée atténue l’importance de la qualité de la comptabilité. Les auteurs constatent en outre que dans les sociétés, qu’elles soient ou non soumises à des contraintes financières, les clauses restrictives qui s’appliquent directement aux dépenses en immobilisations atténuent également l’importance de la qualité de la comptabilité. Les résultats de l’étude donnent à penser que, si les problèmes d’asymétrie de l’information sont susceptibles d’être très importants, la qualité de la comptabilité est elle aussi très importante. Toutefois, l’importance de la qualité de la comptabilité est moindre si les bailleurs de fonds externes ont accès à l’information privilégiée, et elle est nulle si ces bailleurs de fonds imposent à la société des restrictions contractuelles applicables aux investissements. Les auteurs démontrent également que l’accès des banques à l’information privilégiée réduit la sensibilité des liquidités aux flux de trésorerie et atténue l’importance de la qualité de la comptabilité dans la réduction de cette sensibilité. Cette preuve supplémentaire indique, semble‐t‐il, que les résultats obtenus par les auteurs en ce qui a trait à la sensibilité des investissements aux flux de trésorerie ne sont pas le fait d’une erreur de mesure de l’ensemble des occasions d’investissement.

In this paper we examine the factors that determine how firms manage large, firm-specific risks, in this case, product liability. The risk of being sued for defective products or damage from defective products poses a small probability of a great loss to the firm. Product liability exposure arises from the firm's choice of products and markets; choices that are fundamental to the firm's business strategy and that are costly to alter. Firms are unlikely to be naturally hedged by cash flows with respect to product liability risk. Cash flows will likely be negatively correlated with product liability claims since product liability claims reduce product demand and increase costs through legal expenses and claims payments.

In this paper, we examine how the exclusion of voluntary and mandatory accounting changes from the calculation of covenant compliance affects the interest rate charged on the loan. After controlling for self-selection bias and other factors known to affect loan spreads, we find that the rate charged is 84 basis points lower when voluntary accounting changes are excluded and 71 basis points lower when mandatory accounting changes are excluded. Our results suggest that borrowers are willing to pay substantially higher interest rates to retain accounting flexibility that may help them avoid covenant violations and to avoid duplicate record-keeping costs.

This paper analyzes security returns of bank holding companies and insurance companies during periods surrounding the adoption of SFAS 115. We find bank share prices were negatively affected by the examined events, but find little share price reaction for insurance companies. Our evidence suggests banks were adversely affected by the standard because of problems with the standard's market value accounting approach. Cross-sectional analysis of event period returns shows that banks that more frequently traded their investments, with longer maturing investments, and that are more fully hedged against interest rate changes, were the most negatively impacted by the standard.

Despite the unquestionable influence of conservatism, disagreement remains about what economic demands lead to financial reporting conservatism. Research examining lenders’ demands for reporting conservatism has been questioned for ignoring conservative contract modifications. We document that these modifications exist but are not ubiquitous. We find contract modifications are more likely when agency costs are higher and litigation, tax and equity demands for conservatism are lower. However, we find a positive association between unexplained reporting conservatism and contract modifications, suggesting contractual modifications alone do not fulfill lenders’ demands for conservatism.

The SEC issued Staff Accounting Bulletin (SAB) No. 101 to address its concern that firms were masking true performance by managing earnings using accelerated revenue recognition. Critics of this Accounting Bulletin stated that it would eliminate industry-accepted revenue recognition practices and reduce the quality of reported earnings. The FASB's revenue recognition discussions echo these concerns stating that revenues recorded prior to the completion of the earnings process contain value-relevant information about future performance. This paper investigates these two hypotheses using a sample of firms that accelerated revenue recognition prior to SAB No. 101 adoption (SAB 101 firms) and a matched set of firms that were unaffected by this regulation (unaffected firms). Our earnings distribution tests indicate that SAB 101 firms are more likely to meet earnings benchmarks. Specifically, we find that, in the pre-adoption period, SAB 101 firms report fewer small negative and more small positive earnings than they do in the post-adoption period and than do unaffected firms in the pre-adoption period; SAB 101 firms report fewer small negative and more small positive earnings changes in the pre-adoption period compared to the post-adoption period. We also document that SAB 101 firms are more likely to have weaker corporate governance and more likely to have financial covenants, providing them with greater incentives to manage earnings. However, we find that the association between earnings and future cash flows and between unexpected earnings and earnings announcement period returns were higher for SAB 101 firms than for unaffected firms in the preadoption period, indicating higher earnings informativeness for SAB 101 firms. These associations declined for SAB 101 firms in the post-adoption period, suggesting that SAB No. 101 caused a decline in earnings informativeness. Overall, our results suggest that, although the revenue recognition practices targeted by SAB No. 101 have been used by some firms to manage earnings, the regulation's prohibition of revenue recognition prior to completion of the earnings process, on average, results in less informative earnings since these unearned revenues provide value-relevant information.