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Voluntary Income†Increasing Accounting Changes

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  • PETER CHENG
  • DANIEL COULOMBE

Abstract

. This article presents an explanation of the reasons that managers might elect to change accounting methods. Facing adversity with a nontrivial probability of technical default on the debt covenants, the manager is motivated to effect an income†increasing accounting change to circumvent a technical default. Under rational expectations, if investors do not have any prior information about the firm's adversity, the market reaction on an accounting change announcement is predicted to be negative. We postulate that the market impact on the date of change announcement is negatively correlated with the amount of information the investors may have. A sample of 77 firms was selected to test the economic arguments. Investors' reaction to the accounting change was tested by abnormal returns on dates of announcement. Cross†sectional tests associate the investors' reaction with their prior information about the financial status of the sample firms. On the date of the change announcement, the sample firms did not experience a statistically significant negative market reaction. However, in a cross†sectional analysis, the market impact parameter was found to be significantly correlated in a negative manner with the prior information proxy variable.

Suggested Citation

  • Peter Cheng & Daniel Coulombe, 1993. "Voluntary Income†Increasing Accounting Changes," Contemporary Accounting Research, John Wiley & Sons, vol. 10(1), pages 247-272, September.
    • Handle: RePEc:wly:coacre:v:10:y:1993:i:1:p:247-272
    DOI: 10.1111/j.1911-3846.1993.tb00392.x
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    Cited by:

    1. Frank D. Hodge & Roger D. Martin & Jamie H. Pratt, 2006. "Audit Qualifications of Income†Decreasing Accounting Choices," Contemporary Accounting Research, John Wiley & Sons, vol. 23(2), pages 369-394, June.
    2. Kodzo Senyo Adjeyi & Tsotso Kouevi, 2021. "Gestion des données comptables : analyse de l’effet des mesures d’accompagnement sur le comportement déclaratif des dirigeants au Togo," Post-Print hal-03361548, HAL.

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