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Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment

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  • CYRUS AGHAMOLLA
  • NAN LI

Abstract

This study provides evidence that the use of conservative accounting in debt contracting depends on the enforceability of the contract. To test the effect of debt contract enforcement on borrowers' timely loss recognition, we exploit the staggered introduction of enhanced debt contract enforcement in Indian states as a natural experiment, where the implementation of the enforcement is exogenous to the accounting choices and borrowing behavior of firms. The main results show that enhanced enforcement has a significant positive effect on the timeliness of loss recognition of borrowing firms. We find that the effect is strongest for firms that increased their overall borrowing and for firms with high levels of tangible assets, consistent with a collateral‐based explanation. This study also provides causal evidence that firms adopt conservative accounting due to lenders' demand.

Suggested Citation

  • Cyrus Aghamolla & Nan Li, 2018. "Debt Contract Enforcement and Conservatism: Evidence from a Natural Experiment," Journal of Accounting Research, Wiley Blackwell, vol. 56(5), pages 1383-1416, December.
    • Handle: RePEc:bla:joares:v:56:y:2018:i:5:p:1383-1416
    DOI: 10.1111/1475-679X.12238
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    Cited by:

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    2. Jing Zeng & Xiongyuan Wang & Kam C. Chan, 2021. "Does the value‐added tax Reform increase a firm’s collateral bank loans? Evidence from China," Economics of Transition and Institutional Change, John Wiley & Sons, vol. 29(4), pages 681-710, October.
    3. Zhang, Xinyue & Zhong, Yuxiang & Li, Wanli, 2022. "The effect of borrowers' accounting conservatism on lenders' loan loss provisions: Evidence from China's banking industry," International Review of Financial Analysis, Elsevier, vol. 82(C).
    4. Zeng, Jing & Dai, Fangjie & Chan, Kam C., 2023. "The impact of an accelerated depreciation tax policy on employment: Evidence from China," Journal of Asian Economics, Elsevier, vol. 86(C).
    5. Li, Chaoying & Geng, Chunxiao & Sun, Jian & Yuan, Chun, 2024. "Contract enforcement efficiency and corporate vertical specialization: Evidence from a quasi-natural experiment of “announcement of dishonest persons” in China," China Economic Review, Elsevier, vol. 87(C).

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