Accounting Quality and Debt Concentration: Evidence from Internal Control Weakness Disclosures

This paper examines the effect of accounting quality on the degree of debt concentration (i.e., the tendency to rely predominantly on only a few types of debt) in corporate capital structures. Building on theoretical and empirical studies arguing that asymmetric information increases the renegotiation and bankruptcy costs associated with relying on multiple types of debt, the authors predict that lower quality accounting numbers induce firms to choose more concentrated debt structures. Measuring (low) accounting quality with the existence of material internal control weaknesses over financial reporting (ICWs), they find evidence consistent with their prediction: Firms choose more concentrated debt structures after experiencing ICWs. This effect is stronger for more severe ICWs (i.e., company-level rather than account specific ICWs). We find similar results using accounting restatements and audit quality as alternative measures of accounting quality.