Login

Publications  •  Project Statistics

Glossary  •  Schools  •  Disciplines
People Search: 
   
Title/Abstract Search: 

Dissertation Information for Robert Wood Holthausen

NAME:
- Robert Wood Holthausen

DEGREE:
- Ph.D.

DISCIPLINE:
- Accounting

SCHOOL:
- University of Rochester (USA) (1980)

ADVISORS:
- None

COMMITTEE MEMBERS:
- None

MPACT Status: Incomplete - Not_Inspected

Title: THEORY AND EVIDENCE ON THE EFFECT OF BOND COVENANTS AND MANAGEMENT COMPENSATION CONTRACTS ON THE CHOICE OF ACCOUNTING TECHNIQUES: THE CASE OF THE DEPRECIATION SWITCH-BACK

Abstract: The accounting literature at present has no fully developed theory which is capable of explaining why firms change accounting techniques or what determines the set of generally accepted accounting principles. In the past five years, the accounting literature has begun to examine management's incentive to influence the menu of generally accepted accounting principles and to choose among allowable alternative techniques. In this study, the provisions of bond indenture agreements and the form of management compensation contracts are used to develop hypotheses concerning managers' incentives to change accounting techniques. The bond indenture agreements rely in part on accounting numbers to constrain the firm's production, investment and financing decisions. The compensation plans define the manager's bonus as a function of accounting net income. It is argued that mangement's incentives to switch accounting techniques because of the contracts is a function of the firm's leverage, the mix of public and private debt in its capital structure, the extent of the firm's deviation from its dividend and new debt issue constraints, and the existence of a management compensation plan.

The testable implications of the analysis are empirically examined by performing tests on a specific issue, the switch from straight-line to accelerated depreciation for financial reporting purposes only. The primary results of the investigation can be summarized as follows: (1) The abnormal performance of the common stock of a sample of 125 firms which switched to straight-line depreciation from accelerated depreciation for financial reporting purposes only, over the 1962-1978 period, earned statistically insignificant abnormal performance from 60 days before the announcement of the switch to 60 days after the announcement. (2) The abnormal performance of the common stock of those 125 firms with leverage greater than the median leverage, earn statistically significant lower returns than those firms with leverage below the median leverage over the period three days before to two days after the announcement of the switch. There is some evidence that the impact is greater (i.e., more negative) if the debt is publicly held. (3) Leverage and the firm's deviation from new debt issue constraints are significantly negatively correlated. (4) The abnormal performance of the firm is not related to the existence of a mangement compensation plan, the impact of the depreciation change on reported earnings, the deviation from the dividend constraint and the size of the firm.

Two scenarios are described which are consistent with the results. Both scenarios are consistent with the hypothesis that the change in depreciation methods lowers expectations of future earnings, though the effect on all firms is statistically insignificant. The first scenario suggests that the negative effect on leverage is observed because more highly levered firms are closer to their new debt issue constraints, which increases the probability of a costly violation of the constraint. The second scenario suggests that the negative effect of leverage arises simply because changes in the value of the firm have a greater impact on the common equity the more highly levered the firm.

Finally, while evidence on the effects of the change is presented, the question of why managers voluntarily change accounting techniques is left open. Since the change is voluntary, it is reasonable to assume that someone benefits from it. If managers switch depreciation methods because of bond covenant provisions or management compensation contracts, the tests in the paper are not powerful enough to detect that the incentives arising from those contracts are important considerations in the decision to switch methods.

MPACT Scores for Robert Wood Holthausen

A = 0
C = 1
A+C = 1
T = 0
G = 0
W = 0
TD = 0
TA = 0
calculated 2008-05-26 16:40:16

Advisors and Advisees Graph